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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll look at G8 Education Limited’s (ASX:GEM) P/E ratio and reflect on what it tells us about the company’s share price. G8 Education has a P/E ratio of 17.05, based on the last twelve months. That corresponds to an earnings yield of approximately 5.9%.
View our latest analysis for G8 Education
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 G8 Education:
P/E of 17.05 = A$2.8 ÷ A$0.16 (Based on the trailing twelve months to June 2018.)
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. 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 Growth Rates Impact P/E Ratios
If earnings fall then in the future the ‘E’ will be lower. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
G8 Education saw earnings per share decrease by 25% last year. But EPS is up 12% over the last 5 years. And it has shrunk its earnings per share by 6.8% per year over the last three years. This growth rate might warrant a low P/E ratio. This growth rate might warrant a low P/E ratio.
How Does G8 Education’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. As you can see below G8 Education has a P/E ratio that is fairly close for the average for the consumer services industry, which is 16.8.
That indicates that the market expects G8 Education will perform roughly in line with other companies in its industry. So if G8 Education actually outperforms its peers going forward, that should be a positive for the share price. Checking factors such as the tenure of the board and management could help you form your own view on if that will happen.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
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).