The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll look at SP Plus Corporation's (NASDAQ:SP) P/E ratio and reflect on what it tells us about the company's share price. What is SP Plus's P/E ratio? Well, based on the last twelve months it is 18.74. That is equivalent to an earnings yield of about 5.3%.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for SP Plus:
P/E of 18.74 = USD41.22 ÷ USD2.20 (Based on the year to September 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each USD1 the company has earned over the last year. 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 SP Plus Have A Relatively High Or Low P/E For Its Industry?
We can get an indication of market expectations by looking at the P/E ratio. If you look at the image below, you can see SP Plus has a lower P/E than the average (26.4) in the commercial services industry classification.
Its relatively low P/E ratio indicates that SP Plus shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with SP Plus, it's quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. 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.
SP Plus's earnings per share fell by 5.4% in the last twelve months. But EPS is up 20% over the last 5 years.
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. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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 SP Plus's Debt Impact Its P/E Ratio?
Net debt is 35% of SP Plus's market cap. You'd want to be aware of this fact, but it doesn't bother us.
The Verdict On SP Plus's P/E Ratio
SP Plus trades on a P/E ratio of 18.7, which is fairly close to the US market average of 18.9. When you consider the lack of EPS growth last year (along with some debt), it seems the market is optimistic about the future for the business.
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.
You might be able to find a better buy than SP Plus. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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.
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.