This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll show how you can use Johnson Matthey Plc’s (LON:JMAT) P/E ratio to inform your assessment of the investment opportunity. Johnson Matthey has a P/E ratio of 15.98, based on the last twelve months. That corresponds to an earnings yield of approximately 6.3%.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Johnson Matthey:
P/E of 15.98 = £27.7 ÷ £1.73 (Based on the year to September 2018.)
Is A High P/E Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each £1 of company 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.
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. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
Johnson Matthey shrunk earnings per share by 12% over the last year. And EPS is down 2.1% a year, over the last 5 years. This could justify a pessimistic P/E.
How Does Johnson Matthey’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. If you look at the image below, you can see Johnson Matthey has a lower P/E than the average (25.4) in the chemicals industry classification.
Its relatively low P/E ratio indicates that Johnson Matthey shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
Remember: P/E Ratios Don’t Consider The Balance Sheet
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.
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).
How Does Johnson Matthey’s Debt Impact Its P/E Ratio?
Net debt totals 19% of Johnson Matthey’s market cap. That’s enough debt to impact the P/E ratio a little; so keep it in mind if you’re comparing it to companies without debt.
The Bottom Line On Johnson Matthey’s P/E Ratio
Johnson Matthey’s P/E is 16 which is about average (15) in the GB market. 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. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
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.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.