Here's How P/E Ratios Can Help Us Understand Exco Technologies Limited (TSE:XTC)

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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll look at Exco Technologies Limited's (TSE:XTC) P/E ratio and reflect on what it tells us about the company's share price. Based on the last twelve months, Exco Technologies's P/E ratio is 11.27. That corresponds to an earnings yield of approximately 8.9%.

View our latest analysis for Exco Technologies

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 Exco Technologies:

P/E of 11.27 = CA$9.97 ÷ CA$0.88 (Based on the trailing twelve months to December 2018.)

Is A High P/E Ratio Good?

A higher P/E ratio means that buyers have to pay a higher price for each CA$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.'

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. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.

Exco Technologies shrunk earnings per share by 5.8% last year. But over the longer term (5 years) earnings per share have increased by 6.5%. And over the longer term (3 years) earnings per share have decreased 5.8% annually. So it would be surprising to see a high P/E.

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

The P/E ratio essentially measures market expectations of a company. We can see in the image below that the average P/E (24.8) for companies in the machinery industry is higher than Exco Technologies's P/E.

Exco Technologies's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Many investors like to buy stocks when the market is pessimistic about their prospects. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.

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. 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.

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.

Is Debt Impacting Exco Technologies's P/E?

Net debt totals just 3.0% of Exco Technologies's market cap. It would probably trade on a higher P/E ratio if it had a lot of cash, but I doubt it is having a big impact.

The Bottom Line On Exco Technologies's P/E Ratio

Exco Technologies trades on a P/E ratio of 11.3, which is below the CA market average of 15.1. The debt levels are not a major concern, but the lack of EPS growth is likely weighing on sentiment.

When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this freereport on the analyst consensus forecasts could help you make a master move on this stock.

But note: Exco 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).

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 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. Thank you for reading.