This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll look at METAWATER Co., Ltd.’s (OTCPK:MTWT.F) P/E ratio and reflect on what it tells us about the company’s share price. METAWATER has a P/E ratio of 16.08, based on the last twelve months. That corresponds to an earnings yield of approximately 6.2%.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)
Or for METAWATER:
P/E of 16.08 = ¥3075 (Note: this is the share price in the reporting currency, namely, JPY ) ÷ ¥191.22 (Based on the year to December 2018.)
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.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. When earnings grow, the ‘E’ increases, over time. 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.
Notably, METAWATER grew EPS by a whopping 47% in the last year. And its annual EPS growth rate over 3 years is 14%. I’d therefore be a little surprised if its P/E ratio was not relatively high. But earnings per share are down 3.8% per year over the last five years.
How Does METAWATER’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. We can see in the image below that the average P/E (19.7) for companies in the machinery industry is higher than METAWATER’s P/E.
This suggests that market participants think METAWATER will underperform other companies in its industry. Since the market seems unimpressed with METAWATER, it’s quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
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.
How Does METAWATER’s Debt Impact Its P/E Ratio?
METAWATER has net cash of JP¥12b. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Verdict On METAWATER’s P/E Ratio
METAWATER trades on a P/E ratio of 16.1, which is fairly close to the US market average of 17.2. With a strong balance sheet combined with recent growth, the P/E implies the market is quite pessimistic.
Investors should be looking to buy stocks that the market is wrong about. 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. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
But note: METAWATER 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).
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.