In This Article:
The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll look at Magic Software Enterprises Ltd.’s (NASDAQ:MGIC) P/E ratio and reflect on what it tells us about the company’s share price. Based on the last twelve months, Magic Software Enterprises’s P/E ratio is 18.19. That means that at current prices, buyers pay $18.19 for every $1 in trailing yearly profits.
View our latest analysis for Magic Software Enterprises
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Magic Software Enterprises:
P/E of 18.19 = $7.64 ÷ $0.42 (Based on the trailing twelve months to September 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each $1 the company has earned over the last year. 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 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. That means unless the share price increases, the P/E will reduce in a few years. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Notably, Magic Software Enterprises grew EPS by a whopping 58% in the last year. And its annual EPS growth rate over 3 years is 2.7%. So we’d generally expect it to have a relatively high P/E ratio. Unfortunately, earnings per share are down 5.1% a year, over 5 years.
How Does Magic Software Enterprises’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. The image below shows that Magic Software Enterprises has a lower P/E than the average (40.7) P/E for companies in the software industry.
This suggests that market participants think Magic Software Enterprises will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. You should delve deeper. I like to check if company insiders have been buying or selling.
Remember: P/E Ratios Don’t Consider The Balance Sheet
Don’t forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. Theoretically, a business can improve its earnings (and produce a lower P/E in the future), by taking on debt (or spending its remaining cash).