Don’t Sell Constellation Software Inc. (TSE:CSU) Before You Read This

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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 Constellation Software Inc.’s (TSE:CSU) P/E ratio could help you assess the value on offer. Based on the last twelve months, Constellation Software’s P/E ratio is 49.2. That corresponds to an earnings yield of approximately 2.0%.

Check out our latest analysis for Constellation Software

How Do I Calculate Constellation Software’s 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 Constellation Software:

P/E of 49.2 = $880.57 (Note: this is the share price in the reporting currency, namely, USD ) ÷ $17.9 (Based on the trailing twelve months to December 2018.)

Is A High P/E 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 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. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. That means even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.

It’s nice to see that Constellation Software grew EPS by a stonking 71% in the last year. And it has bolstered its earnings per share by 24% per year over the last five years. With that performance, I would expect it to have an above average P/E ratio.

How Does Constellation Software’s P/E Ratio Compare To Its Peers?

The P/E ratio indicates whether the market has higher or lower expectations of a company. As you can see below Constellation Software has a P/E ratio that is fairly close for the average for the software industry, which is 47.8.

TSX:CSU Price Estimation Relative to Market, February 21st 2019
TSX:CSU Price Estimation Relative to Market, February 21st 2019

Its P/E ratio suggests that Constellation Software shareholders think that in the future it will perform about the same as other companies in its industry classification. The company could surprise by performing better than average, in the future. I inform my view byby checking management tenure and remuneration, among other things.

Remember: P/E Ratios Don’t Consider The Balance Sheet

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 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.

Constellation Software’s Balance Sheet

Constellation Software has net cash of US$220m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.

The Verdict On Constellation Software’s P/E Ratio

Constellation Software has a P/E of 49.2. That’s significantly higher than the average in the CA market, which is 14.8. With cash in the bank the company has plenty of growth options — and it is already on the right track. So it does not seem strange that the P/E is above average.

Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E 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.