This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll show how you can use Flexible Solutions International Inc.’s (NYSEMKT:FSI) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Flexible Solutions International’s P/E ratio is 13.16. In other words, at today’s prices, investors are paying $13.16 for every $1 in prior year profit.
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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 Flexible Solutions International:
P/E of 13.16 = $1.36 ÷ $0.10 (Based on the year to September 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each $1 of company earnings. 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
If earnings fall then in the future the ‘E’ will be lower. That means unless the share price falls, the P/E will increase in a few years. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
Flexible Solutions International’s earnings per share fell by 67% in the last twelve months. But over the longer term (5 years) earnings per share have increased by 13%. And over the longer term (3 years) earnings per share have decreased 3.6% annually. This might lead to low expectations.
How Does Flexible Solutions International’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 Flexible Solutions International has a lower P/E than the average (18.7) P/E for companies in the chemicals industry.
Its relatively low P/E ratio indicates that Flexible Solutions International shareholders think it will struggle to do as well as other companies in its industry classification. Many investors like to buy stocks when the market is pessimistic about their prospects. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
Don’t forget that the P/E ratio considers market capitalization. In other words, it does not consider any debt or cash that the company may have on the balance sheet. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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.
Flexible Solutions International’s Balance Sheet
The extra options and safety that comes with Flexible Solutions International’s US$8.1m 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 Flexible Solutions International’s P/E Ratio
Flexible Solutions International trades on a P/E ratio of 13.2, which is below the US market average of 16.8. The recent drop in earnings per share would almost certainly temper expectations, the relatively strong balance sheet will allow the company time to invest in growth. If it achieves that, then there’s real potential that the low P/E could eventually indicate undervaluation.
When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
You might be able to find a better buy than Flexible Solutions International. 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).
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 email@example.com.