Is Compumedics Limited's (ASX:CMP) P/E Ratio Really That Good?
The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to Compumedics Limited's (ASX:CMP), to help you decide if the stock is worth further research. Based on the last twelve months, Compumedics's P/E ratio is 41.01. That means that at current prices, buyers pay A$41.01 for every A$1 in trailing yearly profits.
See our latest analysis for Compumedics
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 Compumedics:
P/E of 41.01 = A$0.68 ÷ A$0.017 (Based on the year to December 2018.)
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. 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 Does Compumedics's P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. You can see in the image below that the average P/E (42.9) for companies in the medical equipment industry is roughly the same as Compumedics's P/E.
Its P/E ratio suggests that Compumedics shareholders think that in the future it will perform about the same as other companies in its industry classification. So if Compumedics actually outperforms its peers going forward, that should be a positive for the share price. Further research into factors such as insider buying and selling, could help you form your own view on whether that is likely.
How Growth Rates Impact P/E Ratios
If earnings fall then in the future the 'E' will be lower. That means unless the share price falls, the P/E will increase in a few years. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
Notably, Compumedics grew EPS by a whopping 39% in the last year. Unfortunately, earnings per share are down 3.0% a year, over 3 years.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
The 'Price' in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. 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).
While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
Compumedics's Balance Sheet
The extra options and safety that comes with Compumedics's AU$2.5m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Verdict On Compumedics's P/E Ratio
Compumedics has a P/E of 41. That's higher than the average in its market, which is 16.4. The excess cash it carries is the gravy on top its fast EPS growth. So based on this analysis we'd expect Compumedics to have a high P/E ratio.
Investors should be looking to buy stocks that the market is wrong about. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine.' So this free report on the analyst consensus forecasts could help you make a master move on this stock.
Of course you might be able to find a better stock than Compumedics. So you may wish to see this free collection of other companies that have grown earnings strongly.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Thank you for reading.
