Here’s How P/E Ratios Can Help Us Understand CLX Communications AB (publ) (STO:SINCH)

This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll look at CLX Communications AB (publ)’s (STO:SINCH) P/E ratio and reflect on what it tells us about the company’s share price. CLX Communications has a P/E ratio of 38.76, based on the last twelve months. That corresponds to an earnings yield of approximately 2.6%.

View our latest analysis for CLX Communications

How Do You Calculate A P/E Ratio?

The formula for P/E is:

Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)

Or for CLX Communications:

P/E of 38.76 = SEK129.8 ÷ SEK3.35 (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 SEK1 the company has earned over the last year. All else being equal, it’s better to pay a low price — but as Warren Buffett said, ‘It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.’

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. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. Then, a lower P/E should attract more buyers, pushing the share price up.

CLX Communications increased earnings per share by a whopping 30% last year. And its annual EPS growth rate over 5 years is 21%. I’d therefore be a little surprised if its P/E ratio was not relatively high.

How Does CLX Communications’s P/E Ratio Compare To Its Peers?

The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that CLX Communications has a P/E ratio that is roughly in line with the software industry average (39).

OM:SINCH Price Estimation Relative to Market, March 15th 2019
OM:SINCH Price Estimation Relative to Market, March 15th 2019

That indicates that the market expects CLX Communications will perform roughly in line with other companies in its industry. If the company has better than average prospects, then the market might be underestimating it. I inform my view byby checking management tenure and remuneration, among other things.

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

Don’t forget that the P/E ratio considers market capitalization. That means it doesn’t take debt or cash into account. 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.

CLX Communications’s Balance Sheet

CLX Communications has net debt worth just 5.8% 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 CLX Communications’s P/E Ratio

CLX Communications has a P/E of 38.8. That’s higher than the average in the SE market, which is 16.8. The company is not overly constrained by its modest debt levels, and it is growing earnings per share. So it does not seem strange that the P/E is above average.

Investors have an opportunity when market expectations about a stock are wrong. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

But note: CLX Communications may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

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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. Thank you for reading.