Why Brooks Macdonald Group plc’s (LON:BRK) 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 look at Brooks Macdonald Group plc’s (LON:BRK) P/E ratio and reflect on what it tells us about the company’s share price. Brooks Macdonald Group has a P/E ratio of 49.2, based on the last twelve months. In other words, at today’s prices, investors are paying £49.2 for every £1 in prior year profit.

View our latest analysis for Brooks Macdonald Group

How Do I Calculate A Price To Earnings Ratio?

The formula for P/E is:

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

Or for Brooks Macdonald Group:

P/E of 49.2 = £17.48 ÷ £0.36 (Based on the trailing twelve months to June 2018.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each £1 of company earnings. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.

How Growth Rates Impact P/E Ratios

When earnings fall, the ‘E’ decreases, over time. That means even if the current P/E is low, it will increase over time if the share price stays flat. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.

Brooks Macdonald Group saw earnings per share decrease by 16% last year. And EPS is down 13% a year, over the last 5 years. This might lead to muted expectations.

How Does Brooks Macdonald Group’s P/E Ratio Compare To Its Peers?

The P/E ratio indicates whether the market has higher or lower expectations of a company. You can see in the image below that the average P/E (19.7) for companies in the capital markets industry is lower than Brooks Macdonald Group’s P/E.

AIM:BRK PE PEG Gauge November 20th 18
AIM:BRK PE PEG Gauge November 20th 18

Its relatively high P/E ratio indicates that Brooks Macdonald Group shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. So further research is always essential. I often monitor director buying and selling.

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

The ‘Price’ in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. 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 Brooks Macdonald Group’s P/E?

The extra options and safety that comes with Brooks Macdonald Group’s UK£32m 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 Brooks Macdonald Group’s P/E Ratio

Brooks Macdonald Group trades on a P/E ratio of 49.2, which is multiples above the GB market average of 15.9. The recent drop in earnings per share would make some investors cautious, but the net cash position means the company has time to improve: and the high P/E suggests the market thinks it will.

When the market is wrong about a stock, it gives savvy investors an opportunity. As value investor Benjamin Graham famously said, ‘In the short run, the market is a voting machine but in the long run, it is a weighing machine.’ 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.

But note: Brooks Macdonald Group may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio 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 editorial-team@simplywallst.com.