This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll show how you can use Argonaut Gold Inc’s (TSE:AR) P/E ratio to inform your assessment of the investment opportunity. Argonaut Gold has a price to earnings ratio of 9.88, based on the last twelve months. That is equivalent to an earnings yield of about 10%.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)
Or for Argonaut Gold:
P/E of 9.88 = $1.02 (Note: this is the share price in the reporting currency, namely, USD ) ÷ $0.10 (Based on the trailing twelve months 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 CA$1 the company has earned over the last year. 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. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. 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.
Argonaut Gold’s earnings per share fell by 11% in the last twelve months. But over the longer term (3 years), earnings per share have increased by 80%. And over the longer term (5 years) earnings per share have decreased 13% annually. This might lead to muted expectations.
How Does Argonaut Gold’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. The image below shows that Argonaut Gold has a P/E ratio that is roughly in line with the metals and mining industry average (10.3).
Argonaut Gold’s P/E tells us that market participants think its prospects are roughly in line with its industry. If the company has better than average prospects, then the market might be underestimating it. Further research into factors such asmanagement tenure, could help you form your own view on whether that is likely.
Remember: P/E Ratios Don’t Consider The Balance Sheet
The ‘Price’ in P/E reflects the market capitalization of the company. That means it doesn’t take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
Argonaut Gold’s Balance Sheet
Since Argonaut Gold holds net cash of US$15m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Verdict On Argonaut Gold’s P/E Ratio
Argonaut Gold’s P/E is 9.9 which is below average (14.5) in the CA market. The recent drop in earnings per share would almost certainly temper expectations, the healthy balance sheet means the company retains potential for future growth. If that occurs, the current low P/E could prove to be temporary.
Investors have an opportunity when market expectations about a stock are wrong. 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 free report on the analyst consensus forecasts could help you make a master move on this stock.
But note: Argonaut Gold may not be the best stock to buy. So take a peek at this free list 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 email@example.com.