This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll show how you can use GR Engineering Services Limited's (ASX:GNG) P/E ratio to inform your assessment of the investment opportunity. What is GR Engineering Services's P/E ratio? Well, based on the last twelve months it is 18.81. That means that at current prices, buyers pay A$18.81 for every A$1 in trailing yearly profits.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for GR Engineering Services:
P/E of 18.81 = A$0.80 ÷ A$0.04 (Based on the year to June 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each A$1 of company earnings. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.
Does GR Engineering Services Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. As you can see below, GR Engineering Services has a higher P/E than the average company (13.0) in the metals and mining industry.
That means that the market expects GR Engineering Services will outperform other companies in its industry. Clearly the market expects growth, but it isn't guaranteed. So further research is always essential. I often monitor director buying and 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. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
GR Engineering Services saw earnings per share decrease by 44% last year. And it has shrunk its earnings per share by 15% per year over the last five years. This growth rate might warrant a below average P/E ratio.
Remember: P/E Ratios Don't Consider The Balance Sheet
Don't forget that the P/E ratio considers market capitalization. That means it doesn't take debt or cash into account. 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.
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).
Is Debt Impacting GR Engineering Services's P/E?
With net cash of AU$31m, GR Engineering Services has a very strong balance sheet, which may be important for its business. Having said that, at 24% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Bottom Line On GR Engineering Services's P/E Ratio
GR Engineering Services trades on a P/E ratio of 18.8, which is fairly close to the AU market average of 18.3. Although the recent drop in earnings per share would keep the market cautious, the relatively strong balance sheet will allow the company to weather a storm; so it isn't very surprising to see that it has a P/E ratio close to the market average.
Investors should be looking to buy stocks that the market is wrong about. 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 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 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.
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 email@example.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.