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Why Fortuna Silver Mines Inc.'s (TSE:FVI) High P/E Ratio Isn't Necessarily A Bad Thing

Simply Wall St

Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. To keep it practical, we'll show how Fortuna Silver Mines Inc.'s (TSE:FVI) P/E ratio could help you assess the value on offer. Fortuna Silver Mines has a P/E ratio of 18.81, based on the last twelve months. That corresponds to an earnings yield of approximately 5.3%.

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View our latest analysis for Fortuna Silver Mines

How Do You Calculate A P/E Ratio?

The formula for P/E is:

Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)

Or for Fortuna Silver Mines:

P/E of 18.81 = $2.64 (Note: this is the share price in the reporting currency, namely, USD ) ÷ $0.14 (Based on the trailing twelve months to March 2019.)

Is A High P/E Ratio Good?

A higher P/E ratio means that buyers have to pay a higher price for each CA$1 the company has earned over the last year. 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 Growth Rates Impact P/E Ratios

Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. Earnings growth means that in the future the 'E' will be higher. And in that case, the P/E ratio itself will drop rather quickly. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Fortuna Silver Mines shrunk earnings per share by 67% over the last year.

Does Fortuna Silver Mines Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio essentially measures market expectations of a company. You can see in the image below that the average P/E (13.3) for companies in the metals and mining industry is lower than Fortuna Silver Mines's P/E.

TSX:FVI Price Estimation Relative to Market, May 20th 2019

Its relatively high P/E ratio indicates that Fortuna Silver Mines 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 investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

The 'Price' in P/E reflects the market capitalization of the company. That means it doesn't take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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).

How Does Fortuna Silver Mines's Debt Impact Its P/E Ratio?

Since Fortuna Silver Mines holds net cash of US$28m, it can spend on growth, justifying a higher P/E ratio than otherwise.

The Bottom Line On Fortuna Silver Mines's P/E Ratio

Fortuna Silver Mines has a P/E of 18.8. That's higher than the average in the CA market, which is 14.9. The recent drop in earnings per share would make some investors cautious, but the healthy balance sheet means the company retains potential for future growth. If fails to eventuate, the current high P/E could prove to be temporary, as the share price falls.

Investors should be looking to buy stocks that the market is wrong about. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. 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 Fortuna Silver Mines. 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.