Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. To keep it practical, we'll show how Capstone Mining Corp.'s (TSE:CS) P/E ratio could help you assess the value on offer. Capstone Mining has a price to earnings ratio of 12.60, based on the last twelve months. That corresponds to an earnings yield of approximately 7.9%.
View our latest analysis for Capstone Mining
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)
Or for Capstone Mining:
P/E of 12.60 = $0.355 ÷ $0.028 (Based on the trailing twelve months to December 2019.)
(Note: the above calculation uses the share price in the reporting currency, namely USD and the calculation results may not be precise due to rounding.)
Is A High P/E Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. 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 Does Capstone Mining's P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. You can see in the image below that the average P/E (9.6) for companies in the metals and mining industry is lower than Capstone Mining's P/E.
Its relatively high P/E ratio indicates that Capstone Mining shareholders think it will perform better than other companies in its industry classification. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
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. And in that case, the P/E ratio itself will drop rather quickly. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Notably, Capstone Mining grew EPS by a whopping 31% in the last year.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. Thus, the metric does not reflect cash or debt held by the company. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.
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.
How Does Capstone Mining's Debt Impact Its P/E Ratio?
Capstone Mining has net debt worth a very significant 115% of its market capitalization. This level of debt justifies a relatively low P/E, so remain cognizant of the debt, if you're comparing it to other stocks.
The Verdict On Capstone Mining's P/E Ratio
Capstone Mining trades on a P/E ratio of 12.6, which is fairly close to the CA market average of 11.9. While it does have meaningful debt levels, it has also produced strong earnings growth recently. The P/E suggests that the market is not convinced EPS will continue to improve strongly.
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 report on the analyst consensus forecasts could help you make a master move on this stock.
You might be able to find a better buy than Capstone Mining. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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.
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. Thank you for reading.
