This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll look at Saracen Mineral Holdings Limited's (ASX:SAR) P/E ratio and reflect on what it tells us about the company's share price. Looking at earnings over the last twelve months, Saracen Mineral Holdings has a P/E ratio of 30.23. In other words, at today's prices, investors are paying A$30.23 for every A$1 in prior year profit.
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 Saracen Mineral Holdings:
P/E of 30.23 = A$3.41 ÷ A$0.11 (Based on the year to June 2019.)
Is A High P/E 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 Saracen Mineral Holdings Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. The image below shows that Saracen Mineral Holdings has a higher P/E than the average (12.7) P/E for companies in the metals and mining industry.
That means that the market expects Saracen Mineral Holdings will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. 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. Earnings growth means that in the future the 'E' will be higher. 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.
Saracen Mineral Holdings increased earnings per share by an impressive 21% over the last twelve months. And it has bolstered its earnings per share by 65% per year over the last five years. So one might expect an above average P/E ratio.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don't forget that the P/E ratio considers market capitalization. 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.
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.
Saracen Mineral Holdings's Balance Sheet
Since Saracen Mineral Holdings holds net cash of AU$119m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Bottom Line On Saracen Mineral Holdings's P/E Ratio
Saracen Mineral Holdings's P/E is 30.2 which is above average (17.9) in its market. Its net cash position supports a higher P/E ratio, as does its solid recent earnings growth. Therefore it seems reasonable that the market would have relatively high expectations of the company
Investors have an opportunity when market expectations about a stock are wrong. 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 Saracen Mineral Holdings. 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).
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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.