The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll show how you can use Ultra Electronics Holdings plc's (LON:ULE) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Ultra Electronics Holdings's P/E ratio is 37.01. In other words, at today's prices, investors are paying £37.01 for every £1 in prior year profit.
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How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Ultra Electronics Holdings:
P/E of 37.01 = £16.12 ÷ £0.44 (Based on the trailing twelve months to December 2018.)
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 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
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. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Ultra Electronics Holdings shrunk earnings per share by 34% over the last year. But over the longer term (3 years), earnings per share have increased by 6.9%. And it has shrunk its earnings per share by 4.5% per year over the last five years. This could justify a pessimistic P/E.
How Does Ultra Electronics Holdings'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 Ultra Electronics Holdings has a higher P/E than the average (23) P/E for companies in the aerospace & defense industry.
That means that the market expects Ultra Electronics Holdings will outperform other companies in its industry. 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.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
The 'Price' in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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).