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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 Frencken Group Limited’s (SGX:E28) P/E ratio to inform your assessment of the investment opportunity. Frencken Group has a price to earnings ratio of 7.01, based on the last twelve months. That means that at current prices, buyers pay SGD7.01 for every SGD1 in trailing yearly profits.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Frencken Group:
P/E of 7.01 = SGD0.41 ÷ SGD0.058 (Based on the trailing twelve months to September 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. 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 Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. Earnings growth means that in the future the ‘E’ will be higher. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
Frencken Group saw earnings per share decrease by 27% last year. But it has grown its earnings per share by 21% per year over the last five years.
How Does Frencken Group’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. We can see in the image below that the average P/E (10.3) for companies in the machinery industry is higher than Frencken Group’s P/E.
Frencken Group’s P/E tells us that market participants think it will not fare as well as its peers in the same industry. Many investors like to buy stocks when the market is pessimistic about their prospects. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
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. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
How Does Frencken Group’s Debt Impact Its P/E Ratio?
Frencken Group’s net debt is 6.8% of its market cap. So it doesn’t have as many options as it would with net cash, but its debt would not have much of an impact on its P/E ratio.
The Bottom Line On Frencken Group’s P/E Ratio
Frencken Group’s P/E is 7 which is below average (11.9) in the SG market. Since it only carries a modest debt load, it’s likely the low expectations implied by the P/E ratio arise from the lack of recent earnings growth.
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. We don’t have analyst forecasts, but shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
But note: Frencken Group 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).
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 firstname.lastname@example.org.