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 PagSeguro Digital Ltd.'s (NYSE:PAGS) P/E ratio to inform your assessment of the investment opportunity. PagSeguro Digital has a price to earnings ratio of 58.25, based on the last twelve months. That means that at current prices, buyers pay $58.25 for every $1 in trailing yearly profits.
How Do I Calculate PagSeguro Digital's Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)
Or for PagSeguro Digital:
P/E of 58.25 = R$209.17 (Note: this is the share price in the reporting currency, namely, BRL ) ÷ R$3.59 (Based on the trailing twelve months to June 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
Does PagSeguro Digital Have A Relatively High Or Low P/E For Its Industry?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. As you can see below, PagSeguro Digital has a higher P/E than the average company (34.2) in the it industry.
That means that the market expects PagSeguro Digital will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should delve deeper. I like to check if company insiders have been buying or 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. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. And in that case, the P/E ratio itself will drop rather quickly. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
It's nice to see that PagSeguro Digital grew EPS by a stonking 43% in the last year. And it has bolstered its earnings per share by 105% per year over the last five years. I'd therefore be a little surprised if its P/E ratio was not relatively high.
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. That means it doesn't take debt or cash into account. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).
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.
How Does PagSeguro Digital's Debt Impact Its P/E Ratio?
PagSeguro Digital has net cash of R$2.0b. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Verdict On PagSeguro Digital's P/E Ratio
PagSeguro Digital's P/E is 58.3 which suggests the market is more focussed on the future opportunity rather than the current level of earnings. The excess cash it carries is the gravy on top its fast EPS growth. So based on this analysis we'd expect PagSeguro Digital to have a high P/E ratio.
Investors have an opportunity when market expectations about a stock are wrong. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
But note: PagSeguro Digital may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio 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 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. Thank you for reading.