This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll look at Skellerup Holdings Limited's (NZSE:SKL) P/E ratio and reflect on what it tells us about the company's share price. Skellerup Holdings has a P/E ratio of 15.51, based on the last twelve months. In other words, at today's prices, investors are paying NZ$15.51 for every NZ$1 in prior year profit.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Skellerup Holdings:
P/E of 15.51 = NZ$2.32 ÷ NZ$0.15 (Based on the trailing twelve months to June 2019.)
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 is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
Does Skellerup Holdings Have A Relatively High Or Low P/E For Its Industry?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Skellerup Holdings has a P/E ratio that is roughly in line with the machinery industry average (15.2).
That indicates that the market expects Skellerup Holdings will perform roughly in line with other companies in its industry. If the company has better than average prospects, then the market might be underestimating it. 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
Probably the most important factor in determining what P/E a company trades on is the earnings growth. When earnings grow, the 'E' increases, over time. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.
Skellerup Holdings saw earnings per share improve by -5.7% last year. And it has improved its earnings per share by 12% per year over the last three years. Unfortunately, earnings per share are down 6.8% a year, over 5 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. That means it doesn't take debt or cash into account. 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 expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
So What Does Skellerup Holdings's Balance Sheet Tell Us?
Net debt totals just 8.1% of Skellerup Holdings's market cap. The market might award it a higher P/E ratio if it had net cash, but its unlikely this low level of net borrowing is having a big impact on the P/E multiple.
The Bottom Line On Skellerup Holdings's P/E Ratio
Skellerup Holdings's P/E is 15.5 which is below average (20.3) in the NZ market. EPS grew over the last twelve months, and debt levels are quite reasonable. The P/E ratio implies the market is cautious about longer term prospects.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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 visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
You might be able to find a better buy than Skellerup Holdings. 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.
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. Thank you for reading.