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 TI Fluid Systems plc's (LON:TIFS) P/E ratio could help you assess the value on offer. What is TI Fluid Systems's P/E ratio? Well, based on the last twelve months it is 12.44. That is equivalent to an earnings yield of about 8.0%.
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 TI Fluid Systems:
P/E of 12.44 = EUR2.90 (Note: this is the share price in the reporting currency, namely, EUR ) ÷ EUR0.23 (Based on the year to June 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each EUR1 of company earnings. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
How Does TI Fluid Systems's P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. As you can see below TI Fluid Systems has a P/E ratio that is fairly close for the average for the auto components industry, which is 11.7.
That indicates that the market expects TI Fluid Systems will perform roughly in line with other companies in its industry. If the company has better than average prospects, then the market might be underestimating it. Further research into factors such as insider buying and selling, could help you form your own view on whether that is likely.
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. That means unless the share price increases, the P/E will reduce in a few years. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
It's great to see that TI Fluid Systems grew EPS by 17% in the last year.
Remember: P/E Ratios Don't Consider The Balance Sheet
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.
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.
So What Does TI Fluid Systems's Balance Sheet Tell Us?
TI Fluid Systems's net debt is 57% of its market cap. This is enough debt that you'd have to make some adjustments before using the P/E ratio to compare it to a company with net cash.
The Verdict On TI Fluid Systems's P/E Ratio
TI Fluid Systems has a P/E of 12.4. That's below the average in the GB market, which is 18.5. While the EPS growth last year was strong, the significant debt levels reduce the number of options available to management. If it continues to grow, then the current low P/E may prove to be unjustified.
Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
You might be able to find a better buy than TI Fluid Systems. 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).
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.
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. Thank you for reading.