Does Southern Cross Electrical Engineering Limited (ASX:SXE) Have A Good P/E Ratio?

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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll show how you can use Southern Cross Electrical Engineering Limited's (ASX:SXE) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Southern Cross Electrical Engineering's P/E ratio is 12.52. That is equivalent to an earnings yield of about 8.0%.

View our latest analysis for Southern Cross Electrical Engineering

How Do I Calculate A Price To Earnings Ratio?

The formula for P/E is:

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

Or for Southern Cross Electrical Engineering:

P/E of 12.52 = A$0.55 ÷ A$0.044 (Based on the trailing twelve months to December 2018.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each A$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 Southern Cross Electrical Engineering's P/E Ratio Compare To Its Peers?

One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. We can see in the image below that the average P/E (15.9) for companies in the construction industry is higher than Southern Cross Electrical Engineering's P/E.

This suggests that market participants think Southern Cross Electrical Engineering will underperform other companies in its industry.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. 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. Then, a lower P/E should attract more buyers, pushing the share price up.

Southern Cross Electrical Engineering increased earnings per share by a whopping 45% last year. But earnings per share are down 18% per year over the last five years.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

The 'Price' in P/E reflects the market capitalization of the company. That means it doesn't take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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.

Southern Cross Electrical Engineering's Balance Sheet

Southern Cross Electrical Engineering has net cash of AU$45m. This is fairly high at 35% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.

The Verdict On Southern Cross Electrical Engineering's P/E Ratio

Southern Cross Electrical Engineering trades on a P/E ratio of 12.5, which is below the AU market average of 16.3. It grew its EPS nicely over the last year, and the healthy balance sheet implies there is more potential for growth. The relatively low P/E ratio implies the market is pessimistic. Since analysts are predicting growth will continue, one might expect to see a higher P/E so it may be worth looking closer.

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 report on the analyst consensus forecasts could help you make a master move on this stock.

But note: Southern Cross Electrical Engineering may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio 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.