In This Article:
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 IDP Education Limited's (ASX:IEL) P/E ratio to inform your assessment of the investment opportunity. IDP Education has a price to earnings ratio of 63.49, based on the last twelve months. That corresponds to an earnings yield of approximately 1.6%.
Check out our latest analysis for IDP Education
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for IDP Education:
P/E of 63.49 = A$16.67 ÷ A$0.26 (Based on the trailing twelve months to June 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each A$1 of company earnings. 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.
Does IDP Education Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio indicates whether the market has higher or lower expectations of a company. You can see in the image below that the average P/E (17.8) for companies in the consumer services industry is a lot lower than IDP Education's P/E.
That means that the market expects IDP Education will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. So further research is always essential. I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. Earnings growth means that in the future the 'E' will be higher. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.
Notably, IDP Education grew EPS by a whopping 28% in the last year. And its annual EPS growth rate over 5 years is 19%. I'd therefore be a little surprised if its P/E ratio was not relatively high.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don't forget that the P/E ratio considers market capitalization. So it won't reflect the advantage of cash, or disadvantage of debt. 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).
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.