Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll show how you can use Alpha Financial Markets Consulting plc's (LON:AFM) P/E ratio to inform your assessment of the investment opportunity. Looking at earnings over the last twelve months, Alpha Financial Markets Consulting has a P/E ratio of 30.83. In other words, at today's prices, investors are paying £30.83 for every £1 in prior year profit.
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 Alpha Financial Markets Consulting:
P/E of 30.83 = £2.37 ÷ £0.08 (Based on the year to September 2019.)
Is A High P/E 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 Does Alpha Financial Markets Consulting'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 (22.2) for companies in the professional services industry is lower than Alpha Financial Markets Consulting's P/E.
That means that the market expects Alpha Financial Markets Consulting will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. So further research is always essential. I often monitor director buying and selling.
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. 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. Then, a lower P/E should attract more buyers, pushing the share price up.
Alpha Financial Markets Consulting increased earnings per share by an impressive 20% over the last twelve months.
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. So it won't reflect the advantage of cash, or disadvantage of debt. 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.
Alpha Financial Markets Consulting's Balance Sheet
Since Alpha Financial Markets Consulting holds net cash of UK£17m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Verdict On Alpha Financial Markets Consulting's P/E Ratio
Alpha Financial Markets Consulting has a P/E of 30.8. That's higher than the average in its market, which is 17.9. Its strong balance sheet gives the company plenty of resources for extra growth, and it has already proven it can grow. So it does not seem strange that the P/E is above average.
Investors should be looking to buy stocks that the market is wrong about. 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.
But note: Alpha Financial Markets Consulting 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).
If you spot an error that warrants correction, please contact the editor at email@example.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.
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.