Despite Its High P/E Ratio, Is Tatton Asset Management plc (LON:TAM) Still Undervalued?
Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll apply a basic P/E ratio analysis to Tatton Asset Management plc's (LON:TAM), to help you decide if the stock is worth further research. Tatton Asset Management has a P/E ratio of 27.56, based on the last twelve months. That corresponds to an earnings yield of approximately 3.6%.
View our latest analysis for Tatton Asset Management
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Tatton Asset Management:
P/E of 27.56 = £2.66 ÷ £0.10 (Based on the year to September 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each £1 of company earnings. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
How Does Tatton Asset Management's P/E Ratio Compare To Its Peers?
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, Tatton Asset Management has a higher P/E than the average company (21.2) in the capital markets industry.
Tatton Asset Management's P/E tells us that market participants think the company will perform better than its industry peers, going forward. The market is optimistic about the future, but that doesn't guarantee future growth. So further research is always essential. I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. And in that case, the P/E ratio itself will drop rather quickly. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Most would be impressed by Tatton Asset Management earnings growth of 15% in the last year. And it has improved its earnings per share by 67% per year over the last three years. With that performance, you might expect an above average P/E ratio. Unfortunately, earnings per share are down 62% a year, over 5 years.
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. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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.
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.
How Does Tatton Asset Management's Debt Impact Its P/E Ratio?
The extra options and safety that comes with Tatton Asset Management's UK£9.2m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Bottom Line On Tatton Asset Management's P/E Ratio
Tatton Asset Management's P/E is 27.6 which is above average (18.0) in its market. With cash in the bank the company has plenty of growth options -- and it is already on the right track. So it does not seem strange that the P/E is above average.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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 the key to an excellent investment decision.
Of course you might be able to find a better stock than Tatton Asset Management. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.
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.
