This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll look at Sierra Metals Inc.'s (TSE:SMT) P/E ratio and reflect on what it tells us about the company's share price. Looking at earnings over the last twelve months, Sierra Metals has a P/E ratio of 28.78. That means that at current prices, buyers pay CA$28.78 for every CA$1 in trailing yearly profits.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)
Or for Sierra Metals:
P/E of 28.78 = $1.48 (Note: this is the share price in the reporting currency, namely, USD ) ÷ $0.051 (Based on the year to March 2019.)
Is A High Price-to-Earnings Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
How Does Sierra Metals's P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. You can see in the image below that the average P/E (16.1) for companies in the metals and mining industry is lower than Sierra Metals's P/E.
Sierra Metals'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
Earnings growth rates have a big influence on P/E ratios. Earnings growth means that in the future the 'E' will be higher. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.
In the last year, Sierra Metals grew EPS like Taylor Swift grew her fan base back in 2010; the 457% gain was both fast and well deserved.
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. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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).
So What Does Sierra Metals's Balance Sheet Tell Us?
Sierra Metals's net debt is 19% of its market cap. This could bring some additional risk, and reduce the number of investment options for management; worth remembering if you compare its P/E to businesses without debt.
The Verdict On Sierra Metals's P/E Ratio
Sierra Metals has a P/E of 28.8. That's higher than the average in its market, which is 14.3. Its debt levels do not imperil its balance sheet and its EPS growth is very healthy indeed. So on this analysis a high P/E ratio seems reasonable.
Investors should be looking to buy stocks that the market is wrong about. 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 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.