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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll look at Super Retail Group Limited's (ASX:SUL) P/E ratio and reflect on what it tells us about the company's share price. Looking at earnings over the last twelve months, Super Retail Group has a P/E ratio of 14.05. That corresponds to an earnings yield of approximately 7.1%.
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 Super Retail Group:
P/E of 14.05 = A$9.1 ÷ A$0.65 (Based on the trailing twelve months to December 2018.)
Is A High P/E Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each A$1 of company earnings. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
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. When earnings grow, the 'E' increases, over time. And in that case, the P/E ratio itself will drop rather quickly. Then, a lower P/E should attract more buyers, pushing the share price up.
Super Retail Group increased earnings per share by a whopping 28% last year. And earnings per share have improved by 4.2% annually, over the last five years. With that performance, I would expect it to have an above average P/E ratio.
How Does Super Retail 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. You can see in the image below that the average P/E (13.2) for companies in the specialty retail industry is roughly the same as Super Retail Group's P/E.
Its P/E ratio suggests that Super Retail Group shareholders think that in the future it will perform about the same as other companies in its industry classification. So if Super Retail Group actually outperforms its peers going forward, that should be a positive for the share price. Further research into factors such asmanagement tenure, could help you form your own view on whether that is likely.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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.
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.
How Does Super Retail Group's Debt Impact Its P/E Ratio?
Super Retail Group has net debt worth 16% of its market capitalization. This could bring some additional risk, and reduce the number of investment options for management; worth remembering if you compare its P/E to businesses without debt.
The Bottom Line On Super Retail Group's P/E Ratio
Super Retail Group trades on a P/E ratio of 14.1, which is below the AU market average of 16.2. The company does have a little debt, and EPS growth was good last year. If it continues to grow, then the current low P/E may prove to be unjustified. Because analysts are predicting more growth in the future, one might have expected to see a higher P/E ratio. You can taker closer look at the fundamentals, here.
Investors have an opportunity when market expectations about a stock are wrong. 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 visual report on analyst forecasts could hold the key to an excellent investment decision.
But note: Super Retail 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).
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 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. Thank you for reading.