Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at Oxford Metrics plc's (LON:OMG) P/E ratio and reflect on what it tells us about the company's share price. Oxford Metrics has a P/E ratio of 27.13, based on the last twelve months. That is equivalent to an earnings yield of about 3.7%.
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Oxford Metrics:
P/E of 27.13 = £0.95 ÷ £0.04 (Based on the trailing twelve months 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 necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
Does Oxford Metrics Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. We can see in the image below that the average P/E (29.6) for companies in the software industry is higher than Oxford Metrics's P/E.
This suggests that market participants think Oxford Metrics will underperform other companies in its industry. Since the market seems unimpressed with Oxford Metrics, it's quite possible it could surprise on the upside. 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
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. That means unless the share price falls, the P/E will increase in a few years. Then, a higher P/E might scare off shareholders, pushing the share price down.
In the last year, Oxford Metrics grew EPS like Taylor Swift grew her fan base back in 2010; the 86% gain was both fast and well deserved. The cherry on top is that the five year growth rate was an impressive 57% per year. With that kind of growth rate we would generally expect a high P/E ratio. Unfortunately, earnings per share are down 13% a year, over 3 years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don't forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. 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).
Is Debt Impacting Oxford Metrics's P/E?
The extra options and safety that comes with Oxford Metrics's UK£11m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Bottom Line On Oxford Metrics's P/E Ratio
Oxford Metrics trades on a P/E ratio of 27.1, which is above its market average of 17.2. The excess cash it carries is the gravy on top its fast EPS growth. So based on this analysis we'd expect Oxford Metrics to have a high P/E ratio.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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.
Of course you might be able to find a better stock than Oxford Metrics. 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 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.
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