Is Games Workshop Group PLC’s (LON:GAW) High P/E Ratio A Problem For Investors?

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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll apply a basic P/E ratio analysis to Games Workshop Group PLC’s (LON:GAW), to help you decide if the stock is worth further research. What is Games Workshop Group’s P/E ratio? Well, based on the last twelve months it is 25.44. That is equivalent to an earnings yield of about 3.9%.

Check out our latest analysis for Games Workshop Group

How Do You Calculate A P/E Ratio?

The formula for price to earnings is:

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

Or for Games Workshop Group:

P/E of 25.44 = £48.3 ÷ £1.9 (Based on the year 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 £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 Does Games Workshop Group’s P/E Ratio Compare To Its Peers?

One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. The image below shows that Games Workshop Group has a higher P/E than the average (20.3) P/E for companies in the leisure industry.

LSE:GAW Price Estimation Relative to Market, July 15th 2019
LSE:GAW Price Estimation Relative to Market, July 15th 2019

Games Workshop Group’s P/E tells us that market participants think the company will perform better than its industry peers, going forward.

How Growth Rates Impact P/E Ratios

Generally speaking the rate of earnings growth has a profound impact on a company’s P/E multiple. Earnings growth means that in the future the ‘E’ will be higher. That means unless the share price increases, the P/E will reduce in a few years. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

Most would be impressed by Games Workshop Group earnings growth of 20% in the last year. And its annual EPS growth rate over 5 years is 34%. This could arguably justify a relatively high P/E ratio.

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

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. So it won’t reflect the advantage of cash, or disadvantage of debt. 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.

Games Workshop Group’s Balance Sheet

The extra options and safety that comes with Games Workshop Group’s UK£25m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.

The Verdict On Games Workshop Group’s P/E Ratio

Games Workshop Group trades on a P/E ratio of 25.4, which is above its market average of 16.5. Its strong balance sheet gives the company plenty of resources for extra growth, and it has already proven it can grow. So it is not surprising the market is probably extrapolating recent growth well into the future, reflected in the relatively high P/E ratio.

Investors have an opportunity when market expectations about a stock are wrong. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. 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.

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.