The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll look at Inter-Rock Minerals Inc.'s (CVE:IRO) P/E ratio and reflect on what it tells us about the company's share price. What is Inter-Rock Minerals's P/E ratio? Well, based on the last twelve months it is 3.25. In other words, at today's prices, investors are paying CA$3.25 for every CA$1 in prior year profit.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)
Or for Inter-Rock Minerals:
P/E of 3.25 = $0.111 ÷ $0.034 (Based on the year to September 2019.)
(Note: the above calculation uses the share price in the reporting currency, namely USD and the calculation results may not be precise due to rounding.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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 Inter-Rock Minerals's P/E Ratio Compare To Its Peers?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. The image below shows that Inter-Rock Minerals has a lower P/E than the average (14.7) P/E for companies in the food industry.
Its relatively low P/E ratio indicates that Inter-Rock Minerals shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Inter-Rock Minerals, it's quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
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. When earnings grow, the 'E' increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Inter-Rock Minerals's earnings per share were pretty steady over the last year. But over the longer term (3 years), earnings per share have increased by 33%.
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.
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.
So What Does Inter-Rock Minerals's Balance Sheet Tell Us?
Inter-Rock Minerals has net debt worth a very significant 235% of its market capitalization. This is a relatively high level of debt, so the stock probably deserves a relatively low P/E ratio. Keep that in mind when comparing it to other companies.
The Verdict On Inter-Rock Minerals's P/E Ratio
Inter-Rock Minerals trades on a P/E ratio of 3.3, which is below the CA market average of 11.7. The P/E reflects market pessimism that probably arises from the lack of recent EPS growth, paired with significant leverage.
Investors should be looking to buy stocks that the market is wrong about. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. Although we don't have analyst forecasts you might want to assess this data-rich visualization of earnings, revenue and cash flow.
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.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.
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