This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll show how you can use Computershare Limited’s (ASX:CPU) P/E ratio to inform your assessment of the investment opportunity. Computershare has a P/E ratio of 24.19, based on the last twelve months. That means that at current prices, buyers pay A$24.19 for every A$1 in trailing yearly profits.
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)
Or for Computershare:
P/E of 24.19 = $13.35 (Note: this is the share price in the reporting currency, namely, USD ) ÷ $0.55 (Based on the trailing twelve months to June 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 A$1 the company has earned over the last year. 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 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 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.
Computershare increased earnings per share by an impressive 13% over the last twelve months. And its annual EPS growth rate over 5 years is 11%. This could arguably justify a relatively high P/E ratio.
How Does Computershare’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 (24.1) for companies in the it industry is roughly the same as Computershare’s P/E.
Its P/E ratio suggests that Computershare shareholders think that in the future it will perform about the same as other companies in its industry classification. The company could surprise by performing better than average, in the future. Further research into factors such asmanagement tenure, could help you form your own view on whether that is likely.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The ‘Price’ in P/E reflects the market capitalization of the company. 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.
Computershare’s Balance Sheet
Computershare’s net debt is 13% of its market cap. It would probably deserve a higher P/E ratio if it was net cash, since it would have more options for growth.
The Verdict On Computershare’s P/E Ratio
Computershare trades on a P/E ratio of 24.2, which is above the AU market average of 15.2. The company is not overly constrained by its modest debt levels, and it is growing earnings per share. Therefore it seems reasonable that the market would have relatively high expectations of the company
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 visual report on analyst forecasts could hold they key to an excellent investment decision.
You might be able to find a better buy than Computershare. 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.