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 The Character Group plc’s (LON:CCT) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Character Group’s P/E ratio is 11.83. In other words, at today’s prices, investors are paying £11.83 for every £1 in prior year profit.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Character Group:
P/E of 11.83 = £5.4 ÷ £0.46 (Based on the year to August 2018.)
Is A High P/E Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each £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
Companies that shrink earnings per share quickly will rapidly decrease the ‘E’ in the equation. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. A higher P/E should indicate the stock is expensive relative to others — and that may encourage shareholders to sell.
Character Group saw earnings per share decrease by 3.9% last year. But over the longer term (5 years) earnings per share have increased by 13%. And EPS is down 11% a year, over the last 3 years. So it would be surprising to see a high P/E.
How Does Character Group’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. If you look at the image below, you can see Character Group has a lower P/E than the average (15.7) in the leisure industry classification.
This suggests that market participants think Character Group will underperform other companies in its industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. 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. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Theoretically, a business can improve its earnings (and produce a lower P/E in the future), by taking on debt (or spending its remaining cash).
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.
Is Debt Impacting Character Group’s P/E?
Character Group has net cash of UK£16m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Bottom Line On Character Group’s P/E Ratio
Character Group has a P/E of 11.8. That’s below the average in the GB market, which is 14.7. The recent drop in earnings per share would almost certainly temper expectations, but the net cash position means the company has time to improve: if so, the low P/E could be an opportunity.
Investors should be looking to buy stocks that the market is wrong about. 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.
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.
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.