This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll apply a basic P/E ratio analysis to McBride plc’s (LON:MCB), to help you decide if the stock is worth further research. McBride has a P/E ratio of 9.52, based on the last twelve months. That means that at current prices, buyers pay £9.52 for every £1 in trailing yearly profits.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for McBride:
P/E of 9.52 = GBP0.63 ÷ GBP0.07 (Based on the year to June 2019.)
Is A High Price-to-Earnings Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. 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 McBride’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. We can see in the image below that the average P/E (20.6) for companies in the household products industry is higher than McBride’s P/E.
McBride’s P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with McBride, 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
When earnings fall, the ‘E’ decreases, over time. That means even if the current P/E is low, it will increase over time if the share price stays flat. Then, a higher P/E might scare off shareholders, pushing the share price down.
McBride’s earnings per share fell by 37% in the last twelve months. And EPS is down 11% a year, over the last 3 years. This might lead to low expectations.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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).
McBride’s Balance Sheet
Net debt totals a substantial 106% of McBride’s market cap. This is a relatively high level of debt, so the stock probably deserves a relatively low P/E ratio. Keep that in mind when comparing it to other companies.
The Bottom Line On McBride’s P/E Ratio
McBride’s P/E is 9.5 which is below average (18.1) in the GB market. The P/E reflects market pessimism that probably arises from the lack of recent EPS growth, paired with significant leverage.
Investors should be looking to buy stocks that the market is wrong about. 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.
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.
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.