Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at Thakral Corporation Ltd's (SGX:AWI) P/E ratio and reflect on what it tells us about the company's share price. Thakral has a price to earnings ratio of 6.59, based on the last twelve months. That corresponds to an earnings yield of approximately 15.2%.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Thakral:
P/E of 6.59 = SGD0.48 ÷ SGD0.07 (Based on the trailing twelve months to September 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each SGD1 the company has earned over the last year. 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.
Does Thakral Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. As you can see below Thakral has a P/E ratio that is fairly close for the average for the retail distributors industry, which is 6.7.
Thakral's P/E tells us that market participants think its prospects are roughly in line with its industry. So if Thakral actually outperforms its peers going forward, that should be a positive for the share price. Further research into factors such as insider buying and selling, could help you form your own view on whether that is likely.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. That means unless the share price increases, the P/E will reduce in a few years. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
In the last year, Thakral grew EPS like Taylor Swift grew her fan base back in 2010; the 65% gain was both fast and well deserved.
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. So it won't reflect the advantage of cash, or disadvantage of debt. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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.
So What Does Thakral's Balance Sheet Tell Us?
Thakral's net debt equates to 25% of its market capitalization. You'd want to be aware of this fact, but it doesn't bother us.
The Verdict On Thakral's P/E Ratio
Thakral's P/E is 6.6 which is below average (13.1) in the SG market. The EPS growth last year was strong, and debt levels are quite reasonable. If the company can continue to grow earnings, then the current P/E may be unjustifiably low.
Investors have an opportunity when market expectations about a stock are wrong. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. We don't have analyst forecasts, but shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
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.
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.
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. Thank you for reading.