This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll show how you can use Galliford Try plc’s (LON:GFRD) P/E ratio to inform your assessment of the investment opportunity. Galliford Try has a price to earnings ratio of 5.94, based on the last twelve months. That is equivalent to an earnings yield of about 17%.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Galliford Try:
P/E of 5.94 = £7.19 ÷ £1.21 (Based on the year 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 £1 the company has earned over the last year. 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
Companies that shrink earnings per share quickly will rapidly decrease the ‘E’ in the equation. That means unless the share price falls, the P/E will increase in a few years. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
Notably, Galliford Try grew EPS by a whopping 105% in the last year. And it has bolstered its earnings per share by 1.1% per year over the last five years. So we’d generally expect it to have a relatively high P/E ratio. In contrast, EPS has decreased by 18%, annually, over 3 years.
How Does Galliford Try’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Galliford Try has a lower P/E than the average (9.9) P/E for companies in the construction industry.
Its relatively low P/E ratio indicates that Galliford Try shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. 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
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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.
Galliford Try’s Balance Sheet
Galliford Try has net cash of UK£97m. 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 Galliford Try’s P/E Ratio
Galliford Try has a P/E of 5.9. That’s below the average in the GB market, which is 15.8. It grew its EPS nicely over the last year, and the healthy balance sheet implies there is more potential for growth. One might conclude that the market is a bit pessimistic, given the low P/E ratio. Because analysts are predicting more growth in the future, one might have expected to see a higher P/E ratio. You can taker closer look at the fundamentals, here.
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 free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
You might be able to find a better buy than Galliford Try. 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).
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.