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Despite Its High P/E Ratio, Is 1300SMILES Limited (ASX:ONT) Still Undervalued?

Simply Wall St

The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll show how you can use 1300SMILES Limited's (ASX:ONT) P/E ratio to inform your assessment of the investment opportunity. What is 1300SMILES's P/E ratio? Well, based on the last twelve months it is 18.57. That corresponds to an earnings yield of approximately 5.4%.

View our latest analysis for 1300SMILES

How Do You Calculate A P/E Ratio?

The formula for P/E is:

Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)

Or for 1300SMILES:

P/E of 18.57 = A$6.09 ÷ A$0.33 (Based on the trailing twelve months to June 2019.)

Is A High P/E Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. 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.

Does 1300SMILES Have A Relatively High Or Low P/E For Its Industry?

One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. As you can see below, 1300SMILES has a higher P/E than the average company (17) in the healthcare industry.

ASX:ONT Price Estimation Relative to Market, August 18th 2019

That means that the market expects 1300SMILES will outperform other companies in its industry. Clearly the market expects growth, but it isn't guaranteed. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

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. 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. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

1300SMILES maintained roughly steady earnings over the last twelve months. But over the longer term (5 years) earnings per share have increased by 9.3%.

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. So it won't reflect the advantage of cash, or disadvantage of debt. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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.

So What Does 1300SMILES's Balance Sheet Tell Us?

1300SMILES's net debt is 5.9% of its 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 Verdict On 1300SMILES's P/E Ratio

1300SMILES's P/E is 18.6 which is above average (15.9) in its market. With debt at prudent levels and improving earnings, it's fair to say the market expects steady progress in the future.

Investors have an opportunity when market expectations about a stock are wrong. 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 visual report on analyst forecasts could hold the key to an excellent investment decision.

But note: 1300SMILES may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

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.