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 Temenos AG’s (VTX:TEMN) P/E ratio could help you assess the value on offer. Based on the last twelve months, Temenos’s P/E ratio is 65.03. That means that at current prices, buyers pay CHF65.03 for every CHF1 in trailing yearly profits.
How Do You Calculate Temenos’s 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 Temenos:
P/E of 65.03 = USD167.14 (Note: this is the share price in the reporting currency, namely, USD ) ÷ USD2.57 (Based on the year to December 2019.)
Is A High P/E Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing 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 Temenos’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. You can see in the image below that the average P/E (33.1) for companies in the software industry is lower than Temenos’s P/E.
Its relatively high P/E ratio indicates that Temenos shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn’t guaranteed. So investors 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. When earnings grow, the ‘E’ increases, over time. 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.
Temenos increased earnings per share by 6.0% last year. And earnings per share have improved by 14% annually, over the last five years.
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. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.
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.
Temenos’s Balance Sheet
Net debt totals just 8.0% of Temenos’s market cap. It would probably trade on a higher P/E ratio if it had a lot of cash, but I doubt it is having a big impact.
The Verdict On Temenos’s P/E Ratio
Temenos’s P/E is 65.0 which suggests the market is more focussed on the future opportunity rather than the current level of earnings. With modest debt relative to its size, and modest earnings growth, the market is likely expecting sustained long-term growth, if not a near-term improvement.
Investors have an opportunity when market expectations about a stock are wrong. As value investor Benjamin Graham famously said, ‘In the short run, the market is a voting machine but in the long run, it is a weighing machine. 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 be able to find a better stock than Temenos. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.
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