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Should You Be Tempted To Sell Michelmersh Brick Holdings plc (LON:MBH) Because Of Its P/E Ratio?

Simply Wall St

The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll show how you can use Michelmersh Brick Holdings plc's (LON:MBH) P/E ratio to inform your assessment of the investment opportunity. Michelmersh Brick Holdings has a price to earnings ratio of 16.10, based on the last twelve months. In other words, at today's prices, investors are paying £16.10 for every £1 in prior year profit.

See our latest analysis for Michelmersh Brick Holdings

How Do I Calculate A Price To Earnings Ratio?

The formula for P/E is:

Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)

Or for Michelmersh Brick Holdings:

P/E of 16.10 = £1.06 ÷ £0.07 (Based on the year to June 2019.)

Is A High P/E 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.

How Does Michelmersh Brick Holdings's P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. The image below shows that Michelmersh Brick Holdings has a higher P/E than the average (13.7) P/E for companies in the basic materials industry.

AIM:MBH Price Estimation Relative to Market, November 19th 2019

That means that the market expects Michelmersh Brick Holdings will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the 'E' will be higher. That means unless the share price increases, the P/E will reduce in a few years. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

Michelmersh Brick Holdings's earnings made like a rocket, taking off 71% last year. The sweetener is that the annual five year growth rate of 28% is also impressive. So I'd be surprised if the P/E ratio was not above average.

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. Thus, the metric does not reflect cash or debt held by the company. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.

So What Does Michelmersh Brick Holdings's Balance Sheet Tell Us?

Michelmersh Brick Holdings's net debt is 14% of its 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 Michelmersh Brick Holdings's P/E Ratio

Michelmersh Brick Holdings's P/E is 16.1 which is about average (17.1) in the GB market. When you consider the impressive EPS growth last year (along with some debt), it seems the market has questions about whether rapid EPS growth will be sustained.

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 visual report on analyst forecasts could hold the key to an excellent investment decision.

You might be able to find a better buy than Michelmersh Brick Holdings. 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 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.