In This Article:
This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll show how you can use Tristel Plc’s (LON:TSTL) P/E ratio to inform your assessment of the investment opportunity. Tristel has a P/E ratio of 35.78, based on the last twelve months. That means that at current prices, buyers pay £35.78 for every £1 in trailing yearly profits.
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How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Tristel:
P/E of 35.78 = £2.73 ÷ £0.076 (Based on the year to June 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. All else being equal, it’s better to pay a low price — but as Warren Buffett said, ‘It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.’
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. Earnings growth means that in the future the ‘E’ will be higher. That means even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
Tristel shrunk earnings per share by 5.4% last year. But over the longer term (5 years) earnings per share have increased by 33%.
How Does Tristel’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. As you can see below, Tristel has a higher P/E than the average company (26.4) in the medical equipment industry.
Tristel’s P/E tells us that market participants think the company will perform better than its industry peers, going forward. Shareholders are clearly optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
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. That means it doesn’t take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.