Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. To keep it practical, we'll show how DLSI's (EPA:ALDLS) P/E ratio could help you assess the value on offer. Based on the last twelve months, DLSI's P/E ratio is 7.24. That means that at current prices, buyers pay €7.24 for every €1 in trailing yearly profits.
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 DLSI:
P/E of 7.24 = EUR18.15 ÷ EUR2.51 (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 a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.
How Does DLSI'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. If you look at the image below, you can see DLSI has a lower P/E than the average (17.1) in the professional services industry classification.
This suggests that market participants think DLSI will underperform other companies in its industry. Since the market seems unimpressed with DLSI, it's quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
When earnings fall, the 'E' decreases, over time. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
DLSI's earnings per share fell by 19% in the last twelve months. But over the longer term (5 years) earnings per share have increased by 5.6%. And over the longer term (3 years) earnings per share have decreased 1.8% annually. This might lead to low expectations.
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. 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.
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
So What Does DLSI's Balance Sheet Tell Us?
Net debt is 32% of DLSI's market cap. While it's worth keeping this in mind, it isn't a worry.
The Bottom Line On DLSI's P/E Ratio
DLSI's P/E is 7.2 which is below average (18.0) in the FR market. Since it only carries a modest debt load, it's likely the low expectations implied by the P/E ratio arise from the lack of recent earnings growth.
Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. We don't have analyst forecasts, but you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
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.
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