Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at Mortgage Advice Bureau (Holdings) plc's (LON:MAB1) P/E ratio and reflect on what it tells us about the company's share price. Looking at earnings over the last twelve months, Mortgage Advice Bureau (Holdings) has a P/E ratio of 22.22. That is equivalent to an earnings yield of about 4.5%.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Mortgage Advice Bureau (Holdings):
P/E of 22.22 = £5.78 ÷ £0.26 (Based on the trailing twelve months to June 2019.)
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 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 Mortgage Advice Bureau (Holdings)'s P/E Ratio Compare To Its Peers?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. The image below shows that Mortgage Advice Bureau (Holdings) has a higher P/E than the average (8.1) P/E for companies in the mortgage industry.
That means that the market expects Mortgage Advice Bureau (Holdings) will outperform other companies in its industry. Clearly the market expects growth, but it isn't guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. That means even if the current P/E is high, it will reduce over time if the share price stays flat. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Mortgage Advice Bureau (Holdings) increased earnings per share by 4.5% last year. And it has bolstered its earnings per share by 28% per year over the last five years.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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 Mortgage Advice Bureau (Holdings)'s Debt Impact Its P/E Ratio?
The extra options and safety that comes with Mortgage Advice Bureau (Holdings)'s UK£24m 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 Mortgage Advice Bureau (Holdings)'s P/E Ratio
Mortgage Advice Bureau (Holdings)'s P/E is 22.2 which is above average (16.9) in its market. Recent earnings growth wasn't bad. And the healthy balance sheet means the company can sustain growth while the P/E suggests shareholders think 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 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.
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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.