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What Does Lucara Diamond Corp.’s (TSE:LUC) P/E Ratio Tell You?

The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll show how you can use Lucara Diamond Corp.’s (TSE:LUC) P/E ratio to inform your assessment of the investment opportunity. Lucara Diamond has a price to earnings ratio of 23.63, based on the last twelve months. That corresponds to an earnings yield of approximately 4.2%.

View our latest analysis for Lucara Diamond

How Do I Calculate A Price To Earnings Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)

Or for Lucara Diamond:

P/E of 23.63 = $1.18 (Note: this is the share price in the reporting currency, namely, USD ) ÷ $0.050 (Based on the year to September 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. 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.’

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.

Lucara Diamond saw earnings per share decrease by 75% last year. And it has shrunk its earnings per share by 3.4% per year over the last five years. This growth rate might warrant a below average P/E ratio.

How Does Lucara Diamond’s P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Lucara Diamond has a higher P/E than the average (9.7) P/E for companies in the metals and mining industry.

TSX:LUC PE PEG Gauge January 25th 19
TSX:LUC PE PEG Gauge January 25th 19

Lucara Diamond’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 investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. That means it doesn’t take debt or cash into account. 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.

Is Debt Impacting Lucara Diamond’s P/E?

The extra options and safety that comes with Lucara Diamond’s US$31m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.

The Verdict On Lucara Diamond’s P/E Ratio

Lucara Diamond has a P/E of 23.6. That’s higher than the average in the CA market, which is 14. The recent drop in earnings per share might keep value investors away, but the healthy balance sheet means the company retains potential for future growth. If fails to eventuate, the current high P/E could prove to be temporary, as the share price falls.

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 report on the analyst consensus forecasts could help you make a master move on this stock.

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.

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 editorial-team@simplywallst.com.

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