This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll look at CapitaLand Limited's (SGX:C31) P/E ratio and reflect on what it tells us about the company's share price. What is CapitaLand's P/E ratio? Well, based on the last twelve months it is 5.65. In other words, at today's prices, investors are paying SGD5.65 for every SGD1 in prior year profit.
How Do I Calculate CapitaLand's Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for CapitaLand:
P/E of 5.65 = SGD2.620 ÷ SGD0.464 (Based on the year to December 2019.)
(Note: the above calculation results may not be precise due to rounding.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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 CapitaLand Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. We can see in the image below that the average P/E (9.8) for companies in the real estate industry is higher than CapitaLand's P/E.
CapitaLand's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with CapitaLand, it's quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
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. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
CapitaLand increased earnings per share by an impressive 10% over the last twelve months. And it has bolstered its earnings per share by 12% per year over the last five years. This could arguably justify a relatively high P/E ratio.
Remember: P/E Ratios Don't Consider The Balance Sheet
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. That means it doesn't take debt or cash into account. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.
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).
How Does CapitaLand's Debt Impact Its P/E Ratio?
CapitaLand has net debt worth a very significant 186% of its market capitalization. This is a relatively high level of debt, so the stock probably deserves a relatively low P/E ratio. Keep that in mind when comparing it to other companies.
The Verdict On CapitaLand's P/E Ratio
CapitaLand trades on a P/E ratio of 5.7, which is below the SG market average of 10.1. While the EPS growth last year was strong, the significant debt levels reduce the number of options available to management. The low P/E ratio suggests current market expectations are muted, implying these levels of growth will not continue.
When the market is wrong about a stock, it gives savvy investors an opportunity. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. 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 CapitaLand. 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).
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned.
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