This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll show how you can use SATS Ltd.’s (SGX:S58) P/E ratio to inform your assessment of the investment opportunity. SATS has a P/E ratio of 19.91, based on the last twelve months. That is equivalent to an earnings yield of about 5.0%.

Check out our latest analysis for SATS

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 SATS:

P/E of 19.91 = SGD4.66 ÷ SGD0.23 (Based on the year to September 2018.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that buyers have to pay a higher price for each SGD1 the company has earned over the last year. 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

P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the ‘E’ increases, over time. 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.

SATS’s earnings per share were pretty steady over the last year. But EPS is up 8.5% over the last 5 years.

How Does SATS’s P/E Ratio Compare To Its Peers?

The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that SATS has a higher P/E than the average (10.2) P/E for companies in the infrastructure industry.

That means that the market expects SATS will outperform other companies in its industry. The market is optimistic about the future, but that doesn’t guarantee future growth. So further research is always essential. I often monitor director buying and selling.

Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits

Don’t forget that the P/E ratio considers market capitalization. That means it doesn’t take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.

How Does SATS’s Debt Impact Its P/E Ratio?

Since SATS holds net cash of S$185m, it can spend on growth, justifying a higher P/E ratio than otherwise.

The Bottom Line On SATS’s P/E Ratio

SATS trades on a P/E ratio of 19.9, which is above the SG market average of 11.8. Recent earnings growth wasn’t bad. And the net cash position provides the company with multiple options. The high P/E suggests the market thinks further growth will come.

Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.