Don't Sell InvoCare Limited (ASX:IVC) Before You Read This
The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll show how you can use InvoCare Limited's (ASX:IVC) P/E ratio to inform your assessment of the investment opportunity. InvoCare has a price to earnings ratio of 42.22, based on the last twelve months. In other words, at today's prices, investors are paying A$42.22 for every A$1 in prior year profit.
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View our latest analysis for InvoCare
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 InvoCare:
P/E of 42.22 = A$15.97 ÷ A$0.38 (Based on the year to December 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each A$1 the company has earned over the last year. 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. Then, a higher P/E might scare off shareholders, pushing the share price down.
InvoCare's earnings per share fell by 57% in the last twelve months. And it has shrunk its earnings per share by 3.3% per year over the last five years. This growth rate might warrant a below average P/E ratio.
How Does InvoCare's P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that InvoCare has a higher P/E than the average (18.2) P/E for companies in the consumer services industry.
InvoCare's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Clearly the market expects growth, but it isn't guaranteed. So further research is always essential. I often monitor director buying and selling.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
The 'Price' in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
InvoCare's Balance Sheet
Net debt totals 22% of InvoCare's market cap. It would probably deserve a higher P/E ratio if it was net cash, since it would have more options for growth.
The Bottom Line On InvoCare's P/E Ratio
InvoCare trades on a P/E ratio of 42.2, which is above the AU market average of 16.2. With some debt but no EPS growth last year, the market has high expectations of future profits.
When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. 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.
But note: InvoCare 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 editorial-team@simplywallst.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.
