Don’t Sell GR Engineering Services Limited (ASX:GNG) Before You Read This
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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 GR Engineering Services Limited’s (ASX:GNG) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, GR Engineering Services’s P/E ratio is 15.27. In other words, at today’s prices, investors are paying A$15.27 for every A$1 in prior year profit.
See our latest analysis for GR Engineering Services
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 GR Engineering Services:
P/E of 15.27 = A$1.16 ÷ A$0.076 (Based on the year to June 2018.)
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. 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. That means even if the current P/E is low, it will increase over time if the share price stays flat. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
GR Engineering Services’s earnings per share fell by 9.7% in the last twelve months. But over the longer term (5 years) earnings per share have increased by 2.9%. And over the longer term (3 years) earnings per share have decreased 9.2% annually. So it would be surprising to see a high P/E.
How Does GR Engineering Services’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. As you can see below, GR Engineering Services has a higher P/E than the average company (10.5) in the metals and mining industry.
GR Engineering Services’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 delve deeper. I like to check if company insiders have been buying or selling.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
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.
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.
GR Engineering Services’s Balance Sheet
Since GR Engineering Services holds net cash of AU$21m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Verdict On GR Engineering Services’s P/E Ratio
GR Engineering Services’s P/E is 15.3 which is about average (15.2) in the AU market. While the absence of growth in the last year is probably causing a degree of pessimism, the healthy balance sheet means the company retains potential for future growth. So it’s not surprising to see it trade on a P/E roughly in line with the market.
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 report on the analyst consensus forecasts could help you make a master move on this stock.
Of course you might be able to find a better stock than GR Engineering Services. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.
