This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to Euromoney Institutional Investor PLC's (LON:ERM), to help you decide if the stock is worth further research. Based on the last twelve months, Euromoney Institutional Investor's P/E ratio is 71.67. That means that at current prices, buyers pay £71.67 for every £1 in trailing yearly profits.
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Euromoney Institutional Investor:
P/E of 71.67 = GBP13.24 ÷ GBP0.18 (Based on the trailing twelve months to September 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 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 Does Euromoney Institutional Investor's P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. As you can see below, Euromoney Institutional Investor has a much higher P/E than the average company (21.9) in the media industry.
Euromoney Institutional Investor's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Shareholders are clearly optimistic, but the future is always uncertain. 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. When earnings grow, the 'E' increases, over time. That means even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
Euromoney Institutional Investor shrunk earnings per share by 70% over the last year. But over the longer term (3 years), earnings per share have increased by 1.9%. And it has shrunk its earnings per share by 21% per year over the last five years. This growth rate might warrant a below average P/E ratio.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. Thus, the metric does not reflect cash or debt held by the company. 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.
Euromoney Institutional Investor's Balance Sheet
Since Euromoney Institutional Investor holds net cash of UK£50m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Bottom Line On Euromoney Institutional Investor's P/E Ratio
Euromoney Institutional Investor's P/E is 71.7 which suggests the market is more focussed on the future opportunity rather than the current level of earnings. The recent drop in earnings per share would make some investors cautious, but the relatively strong balance sheet will allow the company time to invest in growth. Clearly, the high P/E indicates shareholders think it will!
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 visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
Of course you might be able to find a better stock than Euromoney Institutional Investor. 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 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.