Despite Its High P/E Ratio, Is Washington H. Soul Pattinson and Company Limited (ASX:SOL) Still Undervalued?

This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll look at Washington H. Soul Pattinson and Company Limited’s (ASX:SOL) P/E ratio and reflect on what it tells us about the company’s share price. Looking at earnings over the last twelve months, Washington H. Soul Pattinson has a P/E ratio of 20.61. In other words, at today’s prices, investors are paying A$20.61 for every A$1 in prior year profit.

Check out our latest analysis for Washington H. Soul Pattinson

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 Washington H. Soul Pattinson:

P/E of 20.61 = A$21.33 ÷ A$1.03 (Based on the year to July 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 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 Washington H. Soul Pattinson’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. The image below shows that Washington H. Soul Pattinson has a higher P/E than the average (10.2) P/E for companies in the oil and gas industry.

ASX:SOL Price Estimation Relative to Market, December 5th 2019
ASX:SOL Price Estimation Relative to Market, December 5th 2019

Its relatively high P/E ratio indicates that Washington H. Soul Pattinson 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. Earnings growth means that in the future the ‘E’ will be higher. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Washington H. Soul Pattinson shrunk earnings per share by 19% over the last year. But over the longer term (5 years) earnings per share have increased by 13%. The market might therefore be optimistic about the future, but that doesn’t guarantee future growth. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

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

Don’t forget that the P/E ratio considers market capitalization. So it won’t reflect the advantage of cash, or disadvantage of debt. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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.

How Does Washington H. Soul Pattinson’s Debt Impact Its P/E Ratio?

Washington H. Soul Pattinson has net debt worth just 3.7% of its market capitalization. So it doesn’t have as many options as it would with net cash, but its debt would not have much of an impact on its P/E ratio.

The Bottom Line On Washington H. Soul Pattinson’s P/E Ratio

Washington H. Soul Pattinson trades on a P/E ratio of 20.6, which is above its market average of 18.3. With some debt but no EPS growth last year, the market has high expectations of future profits.

When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

You might be able to find a better buy than Washington H. Soul Pattinson. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

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.

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. Thank you for reading.