Is OFX Group Limited's (ASX:OFX) High P/E Ratio A Problem For Investors?
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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 OFX Group Limited's (ASX:OFX) P/E ratio and reflect on what it tells us about the company's share price. OFX Group has a price to earnings ratio of 17.87, based on the last twelve months. That means that at current prices, buyers pay A$17.87 for every A$1 in trailing yearly profits.
Check out our latest analysis for OFX Group
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 OFX Group:
P/E of 17.87 = A$1.47 ÷ A$0.082 (Based on the year to September 2018.)
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 Growth Rates Impact P/E Ratios
If earnings fall then in the future the 'E' will be lower. 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.
OFX Group saw earnings per share improve by -8.4% last year. And it has bolstered its earnings per share by 1.6% per year over the last five years. Unfortunately, earnings per share are down 5.7% a year, over 3 years.
Does OFX Group Have A Relatively High Or Low P/E For Its Industry?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. As you can see below, OFX Group has a higher P/E than the average company (15.3) in the diversified financial industry.
Its relatively high P/E ratio indicates that OFX Group shareholders think it will perform better than other companies in its industry classification. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should delve deeper. I like to check if company insiders have been buying or selling.
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. 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.
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
So What Does OFX Group's Balance Sheet Tell Us?
OFX Group has net cash of AU$67m. This is fairly high at 18% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.
The Verdict On OFX Group's P/E Ratio
OFX Group's P/E is 17.9 which is above average (16.1) in the AU market. Recent earnings growth wasn't bad. And the net cash position provides the company with multiple options. The high P/E suggests the market thinks further growth will come.
When the market is wrong about a stock, it gives savvy investors an opportunity. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. 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.
Of course you might be able to find a better stock than OFX Group. So you may wish to see this free collection of other companies that have grown earnings strongly.
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 editorial-team@simplywallst.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.
