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 Aiton Caldwell SA’s (WSE:AIT) P/E ratio could help you assess the value on offer. Aiton Caldwell has a price to earnings ratio of 8.07, based on the last twelve months. That corresponds to an earnings yield of approximately 12%.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Aiton Caldwell:
P/E of 8.07 = PLN0.65 ÷ PLN0.081 (Based on the year to June 2018.)
Is A High P/E Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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
If earnings fall then in the future the ‘E’ will be lower. That means unless the share price falls, the P/E will increase in a few years. A higher P/E should indicate the stock is expensive relative to others — and that may encourage shareholders to sell.
Aiton Caldwell shrunk earnings per share by 38% over the last year. And over the longer term (5 years) earnings per share have decreased 2.2% annually. This growth rate might warrant a below average P/E ratio.
How Does Aiton Caldwell’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. If you look at the image below, you can see Aiton Caldwell has a lower P/E than the average (10) in the telecom industry classification.
Its relatively low P/E ratio indicates that Aiton Caldwell shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don’t forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. 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).
Aiton Caldwell’s Balance Sheet
The extra options and safety that comes with Aiton Caldwell’s zł7k net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Bottom Line On Aiton Caldwell’s P/E Ratio
Aiton Caldwell has a P/E of 8.1. That’s below the average in the PL market, which is 10. The recent drop in earnings per share would make investors cautious, but the net cash position means the company has time to improve: if so, the low P/E could be an opportunity.
Investors have an opportunity when market expectations about a stock are wrong. 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.’ 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 be able to find a better stock than Aiton Caldwell. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.