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 Texas Pacific Land Trust's (NYSE:TPL) P/E ratio could help you assess the value on offer. Texas Pacific Land Trust has a price to earnings ratio of 16.9, based on the last twelve months. That is equivalent to an earnings yield of about 5.9%.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Texas Pacific Land Trust:
P/E of 16.9 = $659.95 ÷ $39.04 (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 is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
Does Texas Pacific Land Trust Have A Relatively High Or Low P/E For Its Industry?
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 Texas Pacific Land Trust has a higher P/E than the average (8.9) P/E for companies in the oil and gas industry.
Texas Pacific Land Trust'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 investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. When earnings grow, the 'E' increases, over time. 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.
Texas Pacific Land Trust's 98% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. The cherry on top is that the five year growth rate was an impressive 57% per year. With that kind of growth rate we would generally expect a 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. So it won't reflect the advantage of cash, or disadvantage of debt. 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).
Is Debt Impacting Texas Pacific Land Trust's P/E?
The extra options and safety that comes with Texas Pacific Land Trust's US$155m 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 Texas Pacific Land Trust's P/E Ratio
Texas Pacific Land Trust trades on a P/E ratio of 16.9, which is fairly close to the US market average of 17.3. Its net cash position is the cherry on top of its superb EPS growth. So based on this analysis we'd expect Texas Pacific Land Trust to have a higher P/E ratio.
Investors have an opportunity when market expectations about a stock are wrong. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. We don't have analyst forecasts, but you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.
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.
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.