Today, we’ll introduce the concept of the P/E ratio for those who are learning about investing. We’ll show how you can use Croma Security Solutions Group PLC’s (LON:CSSG) P/E ratio to inform your assessment of the investment opportunity. Croma Security Solutions Group has a price to earnings ratio of 8.55, based on the last twelve months. In other words, at today’s prices, investors are paying £8.55 for every £1 in prior year profit.
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 Croma Security Solutions Group:
P/E of 8.55 = £0.87 ÷ £0.10 (Based on the trailing twelve months to December 2018.)
Is A High P/E 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 is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
Does Croma Security Solutions Group Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. The image below shows that Croma Security Solutions Group has a lower P/E than the average (21.6) P/E for companies in the electronic industry.
This suggests that market participants think Croma Security Solutions Group will underperform other companies in its industry.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the ‘E’ will be higher. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
Croma Security Solutions Group’s earnings made like a rocket, taking off 72% last year. The cherry on top is that the five year growth rate was an impressive 65% per year. With that kind of growth rate we would generally expect a high P/E ratio.
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. 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.
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).
How Does Croma Security Solutions Group’s Debt Impact Its P/E Ratio?
Croma Security Solutions Group has net cash of UK£1.8m. This is fairly high at 14% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.
The Bottom Line On Croma Security Solutions Group’s P/E Ratio
Croma Security Solutions Group trades on a P/E ratio of 8.6, which is below the GB market average of 15.7. It grew its EPS nicely over the last year, and the healthy balance sheet implies there is more potential for growth. One might conclude that the market is a bit pessimistic, given the low P/E ratio.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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. We don’t have analyst forecasts, but you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.
Of course you might be able to find a better stock than Croma Security Solutions Group. 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 email@example.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.