Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!
The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll show how you can use CSR Limited’s (ASX:CSR) P/E ratio to inform your assessment of the investment opportunity. What is CSR’s P/E ratio? Well, based on the last twelve months it is 15.43. That corresponds to an earnings yield of approximately 6.5%.
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 CSR:
P/E of 15.43 = A$4.26 ÷ A$0.28 (Based on the trailing twelve months to March 2019.)
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. All else being equal, it’s better to pay a low price — but as Warren Buffett said, ‘It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.’
Does CSR Have A Relatively High Or Low P/E For Its Industry?
We can get an indication of market expectations by looking at the P/E ratio. You can see in the image below that the average P/E (14.7) for companies in the basic materials industry is roughly the same as CSR’s P/E.
Its P/E ratio suggests that CSR shareholders think that in the future it will perform about the same as other companies in its industry classification.
How Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the ‘E’ in the equation. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. Then, a higher P/E might scare off shareholders, pushing the share price down.
CSR’s earnings per share fell by 30% in the last twelve months. But it has grown its earnings per share by 9.6% per year over the last five years.
Remember: P/E Ratios Don’t Consider The Balance Sheet
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. Thus, the metric does not reflect cash or debt held by the company. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).
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 CSR’s Debt Impact Its P/E Ratio?
CSR has net cash of AU$50m. 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 CSR’s P/E Ratio
CSR trades on a P/E ratio of 15.4, which is fairly close to the AU market average of 16.3. While the absence of growth in the last year is probably causing a degree of pessimism, the net cash position means it’s not surprising that expectations put the company roughly in line with the market average P/E.
Investors should be looking to buy stocks that the market is wrong about. 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 be able to find a better stock than CSR. 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 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.