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 Craneware plc's (LON:CRW) P/E ratio to inform your assessment of the investment opportunity. Craneware has a P/E ratio of 54.99, based on the last twelve months. That means that at current prices, buyers pay £54.99 for every £1 in trailing yearly profits.
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)
Or for Craneware:
P/E of 54.99 = USD30.88 (Note: this is the share price in the reporting currency, namely, USD ) ÷ USD0.56 (Based on the trailing twelve months to June 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 Craneware's P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. The image below shows that Craneware has a higher P/E than the average (35.0) P/E for companies in the healthcare services industry.
That means that the market expects Craneware will outperform other companies in its industry. Clearly the market expects growth, but it isn't guaranteed. So further research is always essential. I often monitor director buying and selling.
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 unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.
Craneware's earnings per share fell by 4.8% in the last twelve months. But EPS is up 12% over the last 5 years.
Remember: P/E Ratios Don't Consider The Balance Sheet
The 'Price' in P/E reflects the market capitalization of the company. 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.
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).
So What Does Craneware's Balance Sheet Tell Us?
The extra options and safety that comes with Craneware's US$48m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Verdict On Craneware's P/E Ratio
Craneware trades on a P/E ratio of 55.0, which is above its market average of 18.3. The recent drop in earnings per share might keep value investors away, but the net cash position means the company has time to improve: and the high P/E suggests the market thinks it will.
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 report on the analyst consensus forecasts could help you make a master move on this stock.
You might be able to find a better buy than Craneware. 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).
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.
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