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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we'll show how Clinigen Group Plc's (LON:CLIN) P/E ratio could help you assess the value on offer. Looking at earnings over the last twelve months, Clinigen Group has a P/E ratio of 48.34. That corresponds to an earnings yield of approximately 2.1%.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Clinigen Group:
P/E of 48.34 = £9.8 ÷ £0.20 (Based on the trailing twelve months to December 2018.)
Is A High Price-to-Earnings Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. When earnings grow, the 'E' increases, over time. That means even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
In the last year, Clinigen Group grew EPS like Taylor Swift grew her fan base back in 2010; the 79% gain was both fast and well deserved.
How Does Clinigen Group's P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. You can see in the image below that the average P/E (40.5) for companies in the life sciences industry is lower than Clinigen Group's P/E.
That means that the market expects Clinigen Group will outperform other companies in its industry. Clearly the market expects growth, but it isn't guaranteed. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
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. Thus, the metric does not reflect cash or debt held by the company. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).
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.
How Does Clinigen Group's Debt Impact Its P/E Ratio?
Net debt totals 15% of Clinigen Group's market cap. It would probably deserve a higher P/E ratio if it was net cash, since it would have more options for growth.
The Verdict On Clinigen Group's P/E Ratio
Clinigen Group trades on a P/E ratio of 48.3, which is above the GB market average of 16.5. While the company does use modest debt, its recent earnings growth is superb. So on this analysis a high P/E ratio seems reasonable.
Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. 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 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.
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 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. Thank you for reading.