This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to Vista Group International Limited's (NZSE:VGL), to help you decide if the stock is worth further research. Vista Group International has a price to earnings ratio of 56.62, based on the last twelve months. That corresponds to an earnings yield of approximately 1.8%.
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Vista Group International:
P/E of 56.62 = NZ$3.50 ÷ NZ$0.06 (Based on the trailing twelve months to June 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each NZ$1 the company has earned over the last year. That isn't necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
How Does Vista Group International'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 (39.1) for companies in the software industry is lower than Vista Group International's P/E.
Vista Group International'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.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. When earnings grow, the 'E' increases, over time. That means unless the share price increases, the P/E will reduce in a few years. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Vista Group International's earnings per share fell by 13% in the last twelve months. But over the longer term (5 years) earnings per share have increased by 7.3%.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. Thus, the metric does not reflect cash or debt held by the company. 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 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.
How Does Vista Group International's Debt Impact Its P/E Ratio?
The extra options and safety that comes with Vista Group International's NZ$13m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Bottom Line On Vista Group International's P/E Ratio
Vista Group International has a P/E of 56.6. That's higher than the average in its market, which is 19.6. The recent drop in earnings per share might keep value investors away, but the net cash position means the company has time to improve: and the high P/E suggests the market thinks it will.
When the market is wrong about a stock, it gives savvy investors an opportunity. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
Of course you might be able to find a better stock than Vista Group International. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.
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.