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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll apply a basic P/E ratio analysis to GWA Group Limited’s (ASX:GWA), to help you decide if the stock is worth further research. What is GWA Group’s P/E ratio? Well, based on the last twelve months it is 18.86. In other words, at today’s prices, investors are paying A$18.86 for every A$1 in prior year profit.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for GWA Group:
P/E of 18.86 = A$3.61 ÷ A$0.19 (Based on the trailing twelve months to December 2018.)
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 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 Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company’s P/E multiple. 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. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
GWA Group saw earnings per share improve by -5.1% last year. And its annual EPS growth rate over 5 years is 27%.
Does GWA Group Have A Relatively High Or Low P/E For Its Industry?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. The image below shows that GWA Group has a P/E ratio that is roughly in line with the building industry average (18.9).
Its P/E ratio suggests that GWA Group shareholders think that in the future it will perform about the same as other companies in its industry classification. The company could surprise by performing better than average, in the future. I inform my view byby checking management tenure and remuneration, among other things.
Remember: P/E Ratios Don’t Consider The Balance Sheet
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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.
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.
How Does GWA Group’s Debt Impact Its P/E Ratio?
Since GWA Group holds net cash of AU$7.9m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Verdict On GWA Group’s P/E Ratio
GWA Group trades on a P/E ratio of 18.9, which is above the AU market average of 16.3. EPS was up modestly better over the last twelve months. Also positive, the relatively strong balance sheet will allow for investment in growth — and the P/E indicates shareholders that will happen!
When the market is wrong about a stock, it gives savvy investors an opportunity. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
Of course you might be able to find a better stock than GWA Group. So you may wish to see this free collection of other companies that have grown earnings strongly.
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 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. Thank you for reading.