This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we’ll show how Amiad Water Systems Ltd.’s (LON:AFS) P/E ratio could help you assess the value on offer. Amiad Water Systems has a P/E ratio of 27.84, based on the last twelve months. In other words, at today’s prices, investors are paying £27.84 for every £1 in prior year profit.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)
Or for Amiad Water Systems:
P/E of 27.84 = $2.73 (Note: this is the share price in the reporting currency, namely, USD ) ÷ $0.098 (Based on the year to June 2018.)
Is A High P/E Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each £1 of company earnings. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. 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. Then, a lower P/E should attract more buyers, pushing the share price up.
Amiad Water Systems’s earnings per share fell by 34% in the last twelve months. But it has grown its earnings per share by 1.5% per year over the last three years. And over the longer term (5 years) earnings per share have decreased 3.6% annually. This could justify a pessimistic P/E.
How Does Amiad Water Systems’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. You can see in the image below that the average P/E (18.2) for companies in the machinery industry is lower than Amiad Water Systems’s P/E.
That means that the market expects Amiad Water Systems will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. So investors should delve deeper. I like to check if company insiders have been buying or selling.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
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. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
Is Debt Impacting Amiad Water Systems’s P/E?
Amiad Water Systems’s net debt is 17% of its market cap. That’s enough debt to impact the P/E ratio a little; so keep it in mind if you’re comparing it to companies without debt.
The Verdict On Amiad Water Systems’s P/E Ratio
Amiad Water Systems trades on a P/E ratio of 27.8, which is above the GB market average of 15.4. With modest debt but no EPS growth in the last year, it’s fair to say the P/E implies some optimism about future earnings, from the market.
When the market is wrong about a stock, it gives savvy investors an opportunity. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
You might be able to find a better buy than Amiad Water Systems. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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 firstname.lastname@example.org.