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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 Washington H. Soul Pattinson and Company Limited's (ASX:SOL), to help you decide if the stock is worth further research. Washington H. Soul Pattinson has a price to earnings ratio of 21.03, based on the last twelve months. That means that at current prices, buyers pay A$21.03 for every A$1 in trailing yearly profits.
Check out our latest analysis for Washington H. Soul Pattinson
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Washington H. Soul Pattinson:
P/E of 21.03 = A$21.76 ÷ A$1.03 (Based on the trailing twelve months to July 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each A$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 Does Washington H. Soul Pattinson's P/E Ratio Compare To Its Peers?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. You can see in the image below that the average P/E (9.4) for companies in the oil and gas industry is lower than Washington H. Soul Pattinson's P/E.
That means that the market expects Washington H. Soul Pattinson will outperform other companies in its industry. Clearly the market expects growth, but it isn't guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. Earnings growth means that in the future the 'E' will be higher. That means unless the share price increases, the P/E will reduce in a few years. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Washington H. Soul Pattinson's earnings per share fell by 7.2% in the last twelve months. But EPS is up 13% over the last 5 years.
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. So it won't reflect the advantage of cash, or disadvantage of debt. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).
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.