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Is Topps Tiles Plc's (LON:TPT) High P/E Ratio A Problem For Investors?

Simply Wall St

This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll look at Topps Tiles Plc's (LON:TPT) P/E ratio and reflect on what it tells us about the company's share price. Based on the last twelve months, Topps Tiles's P/E ratio is 16.97. That corresponds to an earnings yield of approximately 5.9%.

Check out our latest analysis for Topps Tiles

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 Topps Tiles:

P/E of 16.97 = £0.74 ÷ £0.04 (Based on the year to March 2019.)

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 Does Topps Tiles's P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. The image below shows that Topps Tiles has a higher P/E than the average (15.0) P/E for companies in the specialty retail industry.

LSE:TPT Price Estimation Relative to Market, November 8th 2019

Its relatively high P/E ratio indicates that Topps Tiles 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 further research is always essential. I often monitor director buying and selling.

How Growth Rates Impact P/E Ratios

If earnings fall then in the future the 'E' will be lower. That means unless the share price falls, the P/E will increase in a few years. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.

Topps Tiles saw earnings per share decrease by 25% last year. And it has shrunk its earnings per share by 6.5% per year over the last five years. This could justify a pessimistic P/E.

Remember: P/E Ratios Don't Consider The Balance Sheet

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. That means it doesn't take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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.

How Does Topps Tiles's Debt Impact Its P/E Ratio?

Net debt totals 12% of Topps Tiles'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 Verdict On Topps Tiles's P/E Ratio

Topps Tiles trades on a P/E ratio of 17.0, which is fairly close to the GB market average of 16.9. 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 have an opportunity when market expectations about a stock are wrong. 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.

But note: Topps Tiles may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

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.