The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll look at Ashley Services Group Limited’s (ASX:ASH) P/E ratio and reflect on what it tells us about the company’s share price. Ashley Services Group has a P/E ratio of 6.76, based on the last twelve months. That corresponds to an earnings yield of approximately 15%.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Ashley Services Group:
P/E of 6.76 = A$0.25 ÷ A$0.037 (Based on the trailing twelve months to December 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each A$1 the company has earned over the last year. 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
Earnings growth rates have a big influence on P/E ratios. When earnings grow, the ‘E’ increases, over time. 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.
It’s nice to see that Ashley Services Group grew EPS by a stonking 196% in the last year. And earnings per share have improved by 137% annually, over the last three years. So we’d generally expect it to have a relatively high P/E ratio. In contrast, EPS has decreased by 18%, annually, over 5 years.
How Does Ashley Services Group’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that Ashley Services Group has a lower P/E than the average (17.1) P/E for companies in the professional services industry.
Its relatively low P/E ratio indicates that Ashley Services Group shareholders think it will struggle to do as well as other companies in its industry classification. Many investors like to buy stocks when the market is pessimistic about their prospects. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
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. 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).
Ashley Services Group’s Balance Sheet
Ashley Services Group has net cash of AU$2.6m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Verdict On Ashley Services Group’s P/E Ratio
Ashley Services Group trades on a P/E ratio of 6.8, which is below the AU market average of 16.3. Not only should the net cash position reduce risk, but the recent growth has been impressive. The relatively low P/E ratio implies the market is pessimistic.
Investors have an opportunity when market expectations about a stock are wrong. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. Although we don’t have analyst forecasts, you might want to assess this data-rich visualization of earnings, revenue and cash flow.
But note: Ashley Services Group 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 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. Thank you for reading.