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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll look at Altium Limited’s (ASX:ALU) P/E ratio and reflect on what it tells us about the company’s share price. Altium has a P/E ratio of 65.32, based on the last twelve months. That corresponds to an earnings yield of approximately 1.5%.
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)
Or for Altium:
P/E of 65.32 = $18.85 (Note: this is the share price in the reporting currency, namely, USD ) ÷ $0.29 (Based on the trailing twelve months to June 2018.)
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 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
Companies that shrink earnings per share quickly will rapidly decrease the ‘E’ in the equation. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. Then, a higher P/E might scare off shareholders, pushing the share price down.
It’s nice to see that Altium grew EPS by a stonking 33% in the last year. And it has bolstered its earnings per share by 12% per year over the last five years. So we’d generally expect it to have a relatively high P/E ratio. In contrast, EPS has decreased by 46%, annually, over 3 years.
How Does Altium’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 (31.8) for companies in the software industry is lower than Altium’s P/E.
Its relatively high P/E ratio indicates that Altium shareholders think it will perform better than other companies in its industry classification. 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.
Remember: P/E Ratios Don’t Consider The Balance Sheet
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. In other words, it does not consider any debt or cash that the company may have on the balance sheet. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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.
Is Debt Impacting Altium’s P/E?
The extra options and safety that comes with Altium’s US$52m 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 Altium’s P/E Ratio
Altium trades on a P/E ratio of 65.3, which is multiples above the AU market average of 15.7. Its net cash position supports a higher P/E ratio, as does its solid recent earnings growth. Therefore it seems reasonable that the market would have relatively high expectations of the company
When the market is wrong about a stock, it gives savvy investors an opportunity. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. So this free visual report on analyst forecasts could hold they key to an excellent investment decision.
Of course you might be able to find a better stock than Altium. So you may wish to see this free collection of other companies that have grown earnings strongly.
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 email@example.com.