Why Sanne Group plc’s (LON:SNN) High P/E Ratio Isn’t Necessarily A Bad Thing

This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll look at Sanne Group plc’s (LON:SNN) P/E ratio and reflect on what it tells us about the company’s share price. What is Sanne Group’s P/E ratio? Well, based on the last twelve months it is 42.83. In other words, at today’s prices, investors are paying £42.83 for every £1 in prior year profit.

See our latest analysis for Sanne Group

How Do I Calculate A Price To Earnings Ratio?

The formula for P/E is:

Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)

Or for Sanne Group:

P/E of 42.83 = £5.51 ÷ £0.13 (Based on the trailing twelve months to December 2018.)

Is A High P/E Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each £1 of company earnings. That isn’t necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.

How Does Sanne Group’s P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. You can see in the image below that the average P/E (16.5) for companies in the capital markets industry is lower than Sanne Group’s P/E.

LSE:SNN Price Estimation Relative to Market, August 18th 2019
LSE:SNN Price Estimation Relative to Market, August 18th 2019

Its relatively high P/E ratio indicates that Sanne Group shareholders think it will perform better than other companies in its industry classification.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. That means even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.

Sanne Group saw earnings per share decrease by 1.8% last year. But EPS is up 4.5% over the last 5 years.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

The ‘Price’ in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. 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 Sanne Group’s Balance Sheet Tell Us?

Sanne Group’s net debt is 6.7% of its market cap. The market might award it a higher P/E ratio if it had net cash, but its unlikely this low level of net borrowing is having a big impact on the P/E multiple.

The Bottom Line On Sanne Group’s P/E Ratio

Sanne Group has a P/E of 42.8. That’s higher than the average in its market, which is 15.8. With modest debt but no EPS growth in the last year, it’s fair to say the P/E implies some optimism about future earnings, from the market.

When the market is wrong about a stock, it gives savvy investors an opportunity. 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 visual report on analyst forecasts could hold the key to an excellent investment decision.

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.

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.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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. Thank you for reading.