In This Article:
This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to Oceania Healthcare Limited's (NZSE:OCA), to help you decide if the stock is worth further research. Looking at earnings over the last twelve months, Oceania Healthcare has a P/E ratio of 13.72. That is equivalent to an earnings yield of about 7.3%.
View our latest analysis for Oceania Healthcare
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Oceania Healthcare:
P/E of 13.72 = NZ$1.03 ÷ NZ$0.08 (Based on the trailing twelve months to May 2019.)
Is A High P/E Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. That isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.
Does Oceania Healthcare Have A Relatively High Or Low P/E For Its Industry?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Oceania Healthcare has a lower P/E than the average (16.1) P/E for companies in the healthcare industry.
This suggests that market participants think Oceania Healthcare will underperform other companies in its industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. You should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. That means even if the current P/E is low, it will increase over time if the share price stays flat. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
Oceania Healthcare saw earnings per share decrease by 41% last year. And it has shrunk its earnings per share by 20% per year over the last three years. This might lead to low expectations.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The 'Price' in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.