Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. To keep it practical, we'll show how Huon Aquaculture Group Limited's (ASX:HUO) P/E ratio could help you assess the value on offer. Huon Aquaculture Group has a price to earnings ratio of 41.40, based on the last twelve months. That means that at current prices, buyers pay A$41.40 for every A$1 in trailing yearly profits.
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 Huon Aquaculture Group:
P/E of 41.40 = A$4.48 ÷ A$0.11 (Based on the trailing twelve months to June 2019.)
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 isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.
How Does Huon Aquaculture Group's P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. As you can see below, Huon Aquaculture Group has a higher P/E than the average company (25.3) in the food industry.
Its relatively high P/E ratio indicates that Huon Aquaculture Group shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn't guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. Earnings growth means that in the future the 'E' will be higher. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.
Huon Aquaculture Group's earnings per share fell by 64% in the last twelve months. But it has grown its earnings per share by 40% per year over the last three years. And EPS is down 28% a year, over the last 5 years. This could justify a pessimistic P/E.
Remember: P/E Ratios Don't Consider The Balance Sheet
Don't forget that the P/E ratio considers market capitalization. That means it doesn't take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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).
So What Does Huon Aquaculture Group's Balance Sheet Tell Us?
Huon Aquaculture Group's net debt equates to 36% of its market capitalization. While that's enough to warrant consideration, it doesn't really concern us.
The Bottom Line On Huon Aquaculture Group's P/E Ratio
Huon Aquaculture Group trades on a P/E ratio of 41.4, which is above its market average of 18.2. With a bit of debt, but a lack of recent growth, it's safe to say the market is expecting improved profit performance from the company, in the next few years.
Investors have an opportunity when market expectations about a stock are wrong. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E 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.