This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we’ll show how PagSeguro Digital Ltd.’s (NYSE:PAGS) P/E ratio could help you assess the value on offer. Based on the last twelve months, PagSeguro Digital’s P/E ratio is 57.29. In other words, at today’s prices, investors are paying $57.29 for every $1 in prior year profit.
How Do I Calculate PagSeguro Digital’s Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)
Or for PagSeguro Digital:
P/E of 57.29 = R$205.82 (Note: this is the share price in the reporting currency, namely, BRL ) ÷ R$3.59 (Based on the trailing twelve months to June 2019.)
Is A High Price-to-Earnings Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. That isn’t a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business’s prospects, relative to stocks with a lower P/E.
How Does PagSeguro Digital’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. You can see in the image below that the average P/E (33.9) for companies in the it industry is lower than PagSeguro Digital’s P/E.
That means that the market expects PagSeguro Digital will outperform other companies in its industry.
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. Earnings growth means that in the future the ‘E’ will be higher. And in that case, the P/E ratio itself will drop rather quickly. Then, a lower P/E should attract more buyers, pushing the share price up.
Notably, PagSeguro Digital grew EPS by a whopping 44% in the last year. And it has bolstered its earnings per share by 105% per year over the last five years. I’d therefore be a little surprised if its P/E ratio was not relatively high.
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. 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).
So What Does PagSeguro Digital’s Balance Sheet Tell Us?
Since PagSeguro Digital holds net cash of R$2.0b, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Bottom Line On PagSeguro Digital’s P/E Ratio
PagSeguro Digital’s P/E is 57.3 which suggests the market is more focussed on the future opportunity rather than the current level of earnings. The excess cash it carries is the gravy on top its fast EPS growth. To us, this is the sort of company that we would expect to carry an above average price tag (relative to earnings).
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 report on the analyst consensus forecasts could help you make a master move on this stock.
But note: PagSeguro Digital 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.