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 Evolution Mining Limited's (ASX:EVN) P/E ratio could help you assess the value on offer. Evolution Mining has a price to earnings ratio of 37.62, based on the last twelve months. That corresponds to an earnings yield of approximately 2.7%.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Evolution Mining:
P/E of 37.62 = A$5.15 ÷ A$0.14 (Based on the trailing twelve months to December 2018.)
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 necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
Does Evolution Mining Have A Relatively High Or Low P/E For Its Industry?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Evolution Mining has a significantly higher P/E than the average (11.7) P/E for companies in the metals and mining industry.
Evolution Mining's P/E tells us that market participants think the company will perform better than its industry peers, going forward. 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
Earnings growth rates have a big influence on P/E ratios. 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. Then, a lower P/E should attract more buyers, pushing the share price up.
Evolution Mining increased earnings per share by an impressive 13% over the last twelve months. And its annual EPS growth rate over 3 years is 50%. This could arguably justify a relatively high P/E ratio.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The 'Price' in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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).
How Does Evolution Mining's Debt Impact Its P/E Ratio?
Net debt totals just 0.4% of Evolution Mining's market cap. It would probably trade on a higher P/E ratio if it had a lot of cash, but I doubt it is having a big impact.
The Bottom Line On Evolution Mining's P/E Ratio
Evolution Mining has a P/E of 37.6. That's higher than the average in its market, which is 16.2. The company is not overly constrained by its modest debt levels, and its recent EPS growth very solid. Therefore, it's not particularly surprising that it has a above average P/E ratio.
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.
You might be able to find a better buy than Evolution Mining. 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 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.