Today, we’ll introduce the concept of the P/E ratio for those who are learning about investing. We’ll show how you can use Aquila Services Group plc’s (LON:AQSG) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Aquila Services Group’s P/E ratio is 23.90. In other words, at today’s prices, investors are paying £23.90 for every £1 in prior year profit.
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 Aquila Services Group:
P/E of 23.90 = £0.34 ÷ £0.01 (Based on the year to September 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each £1 the company has earned over the last year. That isn’t a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business’s prospects, relative to stocks with a lower P/E.
How Does Aquila Services Group’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Aquila Services Group has a P/E ratio that is roughly in line with the professional services industry average (22.4).
Its P/E ratio suggests that Aquila Services Group shareholders think that in the future it will perform about the same as other companies in its industry classification. So if Aquila Services Group actually outperforms its peers going forward, that should be a positive for the share price. Checking factors such as director buying and selling. could help you form your own view on if that will happen.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. Then, a lower P/E should attract more buyers, pushing the share price up.
Aquila Services Group increased earnings per share by an impressive 13% over the last twelve months. And earnings per share have improved by 35% annually, over the last three years. So one might expect an above average P/E ratio. But earnings per share are down 11% 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. That means it doesn’t take debt or cash into account. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).
While growth expenditure doesn’t always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
Aquila Services Group’s Balance Sheet
Aquila Services Group has net cash of UK£1.1m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Verdict On Aquila Services Group’s P/E Ratio
Aquila Services Group’s P/E is 23.9 which is above average (18.0) 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
When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. Although we don’t have analyst forecasts you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.
But note: Aquila Services Group may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
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.