Why Saferoads Holdings Limited’s (ASX:SRH) High P/E Ratio Isn’t Necessarily A Bad Thing

This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll look at Saferoads Holdings Limited’s (ASX:SRH) P/E ratio and reflect on what it tells us about the company’s share price. Saferoads Holdings has a price to earnings ratio of 15.39, based on the last twelve months. That corresponds to an earnings yield of approximately 6.5%.

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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 Saferoads Holdings:

P/E of 15.39 = A$0.30 ÷ A$0.019 (Based on the trailing twelve months to June 2018.)

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 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. 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.

It’s nice to see that Saferoads Holdings grew EPS by a stonking 497% in the last year. And its annual EPS growth rate over 5 years is 80%. I’d therefore be a little surprised if its P/E ratio was not relatively high.

How Does Saferoads Holdings’s P/E Ratio Compare To Its Peers?

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 (15.4) for companies in the electronic industry is roughly the same as Saferoads Holdings’s P/E.

ASX:SRH PE PEG Gauge January 21st 19
ASX:SRH PE PEG Gauge January 21st 19

That indicates that the market expects Saferoads Holdings will perform roughly in line with other companies in its industry. If the company has better than average prospects, then the market might be underestimating it. Checking factors such as the tenure of the board and management could help you form your own view on if that will happen.

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

Don’t forget that the P/E ratio considers market capitalization. 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.

Saferoads Holdings’s Balance Sheet

Saferoads Holdings has net debt worth 13% of its market capitalization. That’s enough debt to impact the P/E ratio a little; so keep it in mind if you’re comparing it to companies without debt.

The Verdict On Saferoads Holdings’s P/E Ratio

Saferoads Holdings’s P/E is 15.4 which is about average (15.2) in the AU market. With only modest debt levels, and strong earnings growth, the market seems to doubt that the growth can be maintained.

Investors should be looking to buy stocks that the market is wrong about. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. Although we don’t have analyst forecasts, you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.

Of course you might be able to find a better stock than Saferoads Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.