Here's What Traffic Technologies Limited's (ASX:TTI) P/E Ratio Is Telling Us

The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we'll show how Traffic Technologies Limited's (ASX:TTI) P/E ratio could help you assess the value on offer. Traffic Technologies has a price to earnings ratio of 1.71, based on the last twelve months. That corresponds to an earnings yield of approximately 59%.

View our latest analysis for Traffic Technologies

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 Traffic Technologies:

P/E of 1.71 = A$0.032 ÷ A$0.019 (Based on the year to June 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 a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.

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. 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. Then, a lower P/E should attract more buyers, pushing the share price up.

Traffic Technologies increased earnings per share by a whopping 411% last year. And its annual EPS growth rate over 3 years is 42%. With that performance, I would expect it to have an above average P/E ratio. Unfortunately, earnings per share are down 21% a year, over 5 years.

How Does Traffic Technologies's P/E Ratio Compare To Its Peers?

The P/E ratio indicates whether the market has higher or lower expectations of a company. If you look at the image below, you can see Traffic Technologies has a lower P/E than the average (21.7) in the infrastructure industry classification.

Its relatively low P/E ratio indicates that Traffic Technologies shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.

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. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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.

Is Debt Impacting Traffic Technologies's P/E?

Traffic Technologies has net debt worth 60% of its market capitalization. This is enough debt that you'd have to make some adjustments before using the P/E ratio to compare it to a company with net cash.

The Verdict On Traffic Technologies's P/E Ratio

Traffic Technologies trades on a P/E ratio of 1.7, which is below the AU market average of 14.6. The company may have significant debt, but EPS growth was good last year. If the company can continue to grow earnings, then the current P/E may be unjustifiably low.

When the market is wrong about a stock, it gives savvy investors an opportunity. 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: Traffic Technologies may not be the best stock to buy. So take a peek at this freelist of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

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.

Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.