This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll look at Airtel Africa Plc’s (LON:AAF) P/E ratio and reflect on what it tells us about the company’s share price. Airtel Africa has a price to earnings ratio of 8.09, based on the last twelve months. That is equivalent to an earnings yield of about 12.4%.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)
Or for Airtel Africa:
P/E of 8.09 = USD0.98 (Note: this is the share price in the reporting currency, namely, USD ) ÷ USD0.12 (Based on the trailing twelve months to December 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 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.
Does Airtel Africa 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. We can see in the image below that the average P/E (24.5) for companies in the wireless telecom industry is higher than Airtel Africa’s P/E.
This suggests that market participants think Airtel Africa will underperform other companies in its industry. Since the market seems unimpressed with Airtel Africa, it’s quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company’s P/E multiple. If earnings are growing quickly, then the ‘E’ in the equation will increase faster than it would otherwise. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
Airtel Africa’s earnings per share fell by 5.0% in the last twelve months.
Remember: P/E Ratios Don’t Consider The Balance Sheet
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.
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
So What Does Airtel Africa’s Balance Sheet Tell Us?
Airtel Africa’s net debt equates to 46% of its market capitalization. While it’s worth keeping this in mind, it isn’t a worry.
The Verdict On Airtel Africa’s P/E Ratio
Airtel Africa has a P/E of 8.1. That’s below the average in the GB market, which is 18.5. With only modest debt, it’s likely the lack of EPS growth at least partially explains the pessimism implied by the 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. 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 Airtel Africa. 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.