The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we'll show how Kelly Partners Group Holdings Limited's (ASX:KPG) P/E ratio could help you assess the value on offer. What is Kelly Partners Group Holdings's P/E ratio? Well, based on the last twelve months it is 18.68. That corresponds to an earnings yield of approximately 5.4%.
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Kelly Partners Group Holdings:
P/E of 18.68 = A$1.00 ÷ A$0.05 (Based on the trailing twelve months to June 2019.)
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 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 Kelly Partners Group Holdings'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. We can see in the image below that the average P/E (20.6) for companies in the professional services industry is higher than Kelly Partners Group Holdings's P/E.
This suggests that market participants think Kelly Partners Group Holdings will underperform other companies in its industry. Since the market seems unimpressed with Kelly Partners Group Holdings, it's quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
When earnings fall, the 'E' decreases, over time. That means even if the current P/E is low, it will increase over time if the share price stays flat. Then, a higher P/E might scare off shareholders, pushing the share price down.
Kelly Partners Group Holdings shrunk earnings per share by 44% over the last year. But over the longer term (5 years) earnings per share have increased by 14%. And over the longer term (3 years) earnings per share have decreased 5.1% annually. This might lead to low expectations.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. 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.
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.
Kelly Partners Group Holdings's Balance Sheet
Kelly Partners Group Holdings's net debt equates to 32% of its market capitalization. While it's worth keeping this in mind, it isn't a worry.
The Bottom Line On Kelly Partners Group Holdings's P/E Ratio
Kelly Partners Group Holdings trades on a P/E ratio of 18.7, which is fairly close to the AU market average of 18.8. Given it has some debt, but didn't grow last year, the P/E indicates the market is expecting higher profits ahead for the business.
Investors should be looking to buy stocks that the market is wrong about. 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. Although we don't have analyst forecasts you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.
Of course you might be able to find a better stock than Kelly Partners Group Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.
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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