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 Japara Healthcare Limited's (ASX:JHC) P/E ratio to inform your assessment of the investment opportunity. Japara Healthcare has a P/E ratio of 19.32, based on the last twelve months. That means that at current prices, buyers pay A$19.32 for every A$1 in trailing yearly profits.
View our latest analysis for Japara Healthcare
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Japara Healthcare:
P/E of 19.32 = A$1.19 ÷ A$0.06 (Based on the trailing twelve months to June 2019.)
Is A High Price-to-Earnings 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. 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 Does Japara Healthcare'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 Japara Healthcare has a P/E ratio that is roughly in line with the healthcare industry average (18.4).
Its P/E ratio suggests that Japara Healthcare shareholders think that in the future it will perform about the same as other companies in its industry classification. So if Japara Healthcare actually outperforms its peers going forward, that should be a positive for the share price. Further research into factors such as insider buying and selling, could help you form your own view on whether that is likely.
How Growth Rates Impact P/E Ratios
When earnings fall, the 'E' decreases, over time. That means unless the share price falls, the P/E will increase in a few years. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
Japara Healthcare saw earnings per share decrease by 30% last year. And over the longer term (3 years) earnings per share have decreased 19% annually. This might lead to low expectations.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don't forget that the P/E ratio considers market capitalization. That means it doesn't take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).