This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll look at Integrated Research Limited’s (ASX:IRI) P/E ratio and reflect on what it tells us about the company’s share price. Based on the last twelve months, Integrated Research’s P/E ratio is 22.96. That means that at current prices, buyers pay A$22.96 for every A$1 in trailing yearly profits.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Integrated Research:
P/E of 22.96 = A$2.92 ÷ A$0.13 (Based on the trailing twelve months to June 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each A$1 of company earnings. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
How Does Integrated Research’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 Integrated Research has a lower P/E than the average (34.5) P/E for companies in the software industry.
Its relatively low P/E ratio indicates that Integrated Research shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Integrated Research, it’s quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. Earnings growth means that in the future the ‘E’ will be higher. That means unless the share price increases, the P/E will reduce in a few years. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Most would be impressed by Integrated Research earnings growth of 14% in the last year. And earnings per share have improved by 20% annually, over the last five years. With that performance, you might expect an above average P/E ratio.
Remember: P/E Ratios Don’t Consider The Balance Sheet
The ‘Price’ in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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.
So What Does Integrated Research’s Balance Sheet Tell Us?
Integrated Research has net cash of AU$9.3m. 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 Integrated Research’s P/E Ratio
Integrated Research has a P/E of 23.0. That’s higher than the average in its market, which is 18.4. Its net cash position supports a higher P/E ratio, as does its solid recent earnings growth. So it is not surprising the market is probably extrapolating recent growth well into the future, reflected in the relatively high P/E ratio.
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 visual report on analyst forecasts could hold the key to an excellent investment decision.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E 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.