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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll show how you can use Electrocomponents plc’s (LON:ECM) P/E ratio to inform your assessment of the investment opportunity. Electrocomponents has a P/E ratio of 15.37, based on the last twelve months. That is equivalent to an earnings yield of about 6.5%.
View our latest analysis for Electrocomponents
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Electrocomponents:
P/E of 15.37 = £5.75 ÷ £0.37 (Based on the year to September 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each £1 of company earnings. That isn’t necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.
Electrocomponents increased earnings per share by a whopping 54% last year. And its annual EPS growth rate over 5 years is 20%. With that performance, I would expect it to have an above average P/E ratio.
How Does Electrocomponents’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. The image below shows that Electrocomponents has a lower P/E than the average (16.6) P/E for companies in the electronic industry.
Its relatively low P/E ratio indicates that Electrocomponents shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Electrocomponents, it’s quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. Thus, the metric does not reflect cash or debt held by the company. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.