This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). To keep it practical, we’ll show how NanoEnTek Inc.’s (KOSDAQ:039860) P/E ratio could help you assess the value on offer. NanoEnTek has a price to earnings ratio of 34.21, based on the last twelve months. That means that at current prices, buyers pay ₩34.21 for every ₩1 in trailing yearly profits.
How Do You Calculate NanoEnTek’s P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for NanoEnTek:
P/E of 34.21 = ₩5700.000 ÷ ₩166.601 (Based on the year to September 2019.)
(Note: the above calculation results may not be precise due to rounding.)
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 NanoEnTek 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. The image below shows that NanoEnTek has a P/E ratio that is roughly in line with the life sciences industry average (34.0).
Its P/E ratio suggests that NanoEnTek shareholders think that in the future it will perform about the same as other companies in its industry classification. The company could surprise by performing better than average, in the future. Checking factors such as director buying and selling. could help you form your own view on if that will happen.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. If earnings are growing quickly, then the ‘E’ in the equation will increase faster than it would otherwise. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
NanoEnTek’s earnings made like a rocket, taking off 451% last year.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
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 spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
How Does NanoEnTek’s Debt Impact Its P/E Ratio?
Since NanoEnTek holds net cash of ₩7.4b, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Verdict On NanoEnTek’s P/E Ratio
NanoEnTek trades on a P/E ratio of 34.2, which is above its market average of 14.1. Its net cash position is the cherry on top of its superb EPS growth. So based on this analysis we’d expect NanoEnTek to have a high P/E ratio.
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. We don’t have analyst forecasts, but shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
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.
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.
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. Thank you for reading.