Why Walker Greenbank PLC's (LON:WGB) High P/E Ratio Isn't Necessarily A Bad Thing

This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to Walker Greenbank PLC's (LON:WGB), to help you decide if the stock is worth further research. Walker Greenbank has a P/E ratio of 12.39, based on the last twelve months. In other words, at today's prices, investors are paying £12.39 for every £1 in prior year profit.

View our latest analysis for Walker Greenbank

How Do I Calculate A Price To Earnings Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)

Or for Walker Greenbank:

P/E of 12.39 = £0.81 ÷ £0.07 (Based on the trailing twelve months to July 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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.

Does Walker Greenbank Have A Relatively High Or Low P/E For Its Industry?

One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. You can see in the image below that the average P/E (10.6) for companies in the consumer durables industry is lower than Walker Greenbank's P/E.

Its relatively high P/E ratio indicates that Walker Greenbank shareholders think it will perform better than other companies in its industry classification.

How Growth Rates Impact P/E Ratios

If earnings fall then in the future the 'E' will be lower. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. Then, a higher P/E might scare off shareholders, pushing the share price down.

Walker Greenbank shrunk earnings per share by 60% over the last year. And over the longer term (5 years) earnings per share have decreased 6.7% annually. This growth rate might warrant a below average P/E ratio. If the company can grow EPS strongly, the market may improve its opinion of it. I would further inform my view by checking insider buying and selling., among other things.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

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.

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).

Walker Greenbank's Balance Sheet

Walker Greenbank has net cash of UK£922k. 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 Walker Greenbank's P/E Ratio

Walker Greenbank has a P/E of 12.4. That's below the average in the GB market, which is 16.9. The recent drop in earnings per share would almost certainly temper expectations, the relatively strong balance sheet will allow the company time to invest in growth. If it achieves that, then there's real potential that the low P/E could eventually indicate undervaluation.

Investors have an opportunity when market expectations about a stock are wrong. 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 be able to find a better stock than Walker Greenbank. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.