Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll show how you can use Asaleo Care Limited's (ASX:AHY) P/E ratio to inform your assessment of the investment opportunity. What is Asaleo Care's P/E ratio? Well, based on the last twelve months it is 22.66. That is equivalent to an earnings yield of about 4.4%.
See our latest analysis for Asaleo Care
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 Asaleo Care:
P/E of 22.66 = A$0.96 ÷ A$0.043 (Based on the trailing twelve months to June 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each A$1 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 Does Asaleo Care's P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Asaleo Care has a P/E ratio that is roughly in line with the personal products industry average (22).
That indicates that the market expects Asaleo Care 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. Checking factors such as director buying and selling. could help you form your own view on if that will happen.
How Growth Rates Impact P/E Ratios
If earnings fall then in the future the 'E' will be lower. That means even if the current P/E is low, it will increase over time if the share price stays flat. Then, a higher P/E might scare off shareholders, pushing the share price down.
Notably, Asaleo Care grew EPS by a whopping 38% in the last year. In contrast, EPS has decreased by 29%, annually, over 3 years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. In other words, it does not consider any debt or cash that the company may have on the balance sheet. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on 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.