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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll look at CSG Systems International, Inc.'s (NASDAQ:CSGS) P/E ratio and reflect on what it tells us about the company's share price. Based on the last twelve months, CSG Systems International's P/E ratio is 22.23. In other words, at today's prices, investors are paying $22.23 for every $1 in prior year profit.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for CSG Systems International:
P/E of 22.23 = $48.99 ÷ $2.2 (Based on the year to March 2019.)
Is A High Price-to-Earnings Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing 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 CSG Systems International's P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. We can see in the image below that the average P/E (36.2) for companies in the it industry is higher than CSG Systems International's P/E.
CSG Systems International's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Many investors like to buy stocks when the market is pessimistic about their prospects. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
When earnings fall, the 'E' decreases, over time. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. Then, a higher P/E might scare off shareholders, pushing the share price down.
It's nice to see that CSG Systems International grew EPS by a stonking 30% in the last year. And its annual EPS growth rate over 5 years is 9.0%. I'd therefore be a little surprised if its P/E ratio was not relatively high. But earnings per share are down 3.1% per year over the last three years.
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. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on 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 CSG Systems International's Balance Sheet Tell Us?
CSG Systems International's net debt is 14% of its market cap. 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 Verdict On CSG Systems International's P/E Ratio
CSG Systems International trades on a P/E ratio of 22.2, which is above its market average of 18. Its debt levels do not imperil its balance sheet and its EPS growth is very healthy indeed. So to be frank we are not surprised it has a high P/E ratio.
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.' So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
You might be able to find a better buy than CSG Systems International. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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 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. Thank you for reading.