Is Evolution Gaming Group AB (publ)'s (STO:EVO) High P/E Ratio A Problem For Investors?

This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll show how you can use Evolution Gaming Group AB (publ)'s (STO:EVO) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Evolution Gaming Group's P/E ratio is 38.36. In other words, at today's prices, investors are paying SEK38.36 for every SEK1 in prior year profit.

View our latest analysis for Evolution Gaming Group

How Do I Calculate Evolution Gaming Group's Price To Earnings Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)

Or for Evolution Gaming Group:

P/E of 38.36 = SEK27.32 (Note: this is the share price in the reporting currency, namely, EUR ) ÷ SEK0.71 (Based on the year to September 2019.)

Is A High P/E Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing 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 Does Evolution Gaming 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. As you can see below, Evolution Gaming Group has a higher P/E than the average company (13.9) in the hospitality industry.

Evolution Gaming Group'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 investors should delve deeper. I like to check if company insiders have been buying or selling.

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. Then, a lower P/E should attract more buyers, pushing the share price up.

Evolution Gaming Group's earnings made like a rocket, taking off 69% last year. The cherry on top is that the five year growth rate was an impressive 59% per year. With that kind of growth rate we would generally expect a high P/E ratio.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

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 investing in growth. That means taking on debt (or spending its cash).

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.

Is Debt Impacting Evolution Gaming Group's P/E?

The extra options and safety that comes with Evolution Gaming Group's €135m 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 Evolution Gaming Group's P/E Ratio

Evolution Gaming Group has a P/E of 38.4. That's higher than the average in its market, which is 18.8. Its net cash position is the cherry on top of its superb EPS growth. So based on this analysis we'd expect Evolution Gaming Group to have a high P/E ratio.

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 visual report on analyst forecasts could hold the key to an excellent investment decision.

Of course you might be able to find a better stock than Evolution Gaming Group. So you may wish to see this free collection of other companies that have grown earnings strongly.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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.