The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we’ll show how Dechra Pharmaceuticals PLC’s (LON:DPH) P/E ratio could help you assess the value on offer. Dechra Pharmaceuticals has a P/E ratio of 65.47, based on the last twelve months. In other words, at today’s prices, investors are paying £65.47 for every £1 in prior year profit.
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How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Dechra Pharmaceuticals:
P/E of 65.47 = £24.38 ÷ £0.37 (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
Earnings growth rates have a big influence on P/E ratios. When earnings grow, the ‘E’ increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Dechra Pharmaceuticals increased earnings per share by a whopping 33% last year. And it has bolstered its earnings per share by 17% per year over the last five years. So we’d generally expect it to have a relatively high P/E ratio.
How Does Dechra Pharmaceuticals’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. The image below shows that Dechra Pharmaceuticals has a higher P/E than the average (38.7) P/E for companies in the pharmaceuticals industry.
Dechra Pharmaceuticals’s P/E tells us that market participants think the company will perform better than its industry peers, going forward. 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
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. 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.
How Does Dechra Pharmaceuticals’s Debt Impact Its P/E Ratio?
Dechra Pharmaceuticals has net debt worth just 8.5% of its market capitalization. It would probably trade on a higher P/E ratio if it had a lot of cash, but I doubt it is having a big impact.
The Bottom Line On Dechra Pharmaceuticals’s P/E Ratio
Dechra Pharmaceuticals has a P/E of 65.5. That’s significantly higher than the average in the GB market, which is 15.7. Its debt levels do not imperil its balance sheet and it has already proven it can grow. Therefore it seems reasonable that the market would have relatively high expectations of the company
Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
You might be able to find a better buy than Dechra Pharmaceuticals. 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.