This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). To keep it practical, we’ll show how Corsa Coal Corp’s (CVE:CSO) P/E ratio could help you assess the value on offer. Corsa Coal has a P/E ratio of 1.09, based on the last twelve months. In other words, at today’s prices, investors are paying CA$1.09 for every CA$1 in prior year profit.
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 Corsa Coal:
P/E of 1.09 = $0.52 (Note: this is the share price in the reporting currency, namely, USD ) ÷ $0.47 (Based on the year to September 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each CA$1 of company earnings. That isn’t necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the ‘E’ increases, over time. 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.
It’s nice to see that Corsa Coal grew EPS by a stonking 499% in the last year. And it has improved its earnings per share by 110% per year over the last three years. I’d therefore be a little surprised if its P/E ratio was not relatively high. Unfortunately, earnings per share are down 15% a year, over 5 years.
How Does Corsa Coal’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. The image below shows that Corsa Coal has a lower P/E than the average (9.1) P/E for companies in the metals and mining industry.
Its relatively low P/E ratio indicates that Corsa Coal shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Corsa Coal, it’s quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don’t forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. 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).
Is Debt Impacting Corsa Coal’s P/E?
Corsa Coal has net debt worth 56% 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 Corsa Coal’s P/E Ratio
Corsa Coal trades on a P/E ratio of 1.1, which is below the CA market average of 13.9. While the EPS growth last year was strong, the significant debt levels reduce the number of options available to management. If it continues to grow, then the current low P/E may prove to be unjustified.
Investors should be looking to buy stocks that the market is wrong about. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free visual report on analyst forecasts could hold they key to an excellent investment decision.
Of course you might be able to find a better stock than Corsa Coal. 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 firstname.lastname@example.org.