This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll look at CI Resources Limited’s (ASX:CII) P/E ratio and reflect on what it tells us about the company’s share price. CI Resources has a price to earnings ratio of 8.65, based on the last twelve months. In other words, at today’s prices, investors are paying A$8.65 for every A$1 in prior year profit.
See our latest analysis for CI Resources
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 CI Resources:
P/E of 8.65 = A$1.52 ÷ A$0.18 (Based on the year to December 2018.)
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. 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.
How Growth Rates Impact P/E Ratios
If earnings fall then in the future the ‘E’ will be lower. That means unless the share price falls, the P/E will increase in a few years. Then, a higher P/E might scare off shareholders, pushing the share price down.
CI Resources shrunk earnings per share by 8.1% last year. And it has shrunk its earnings per share by 20% per year over the last three years. This growth rate might warrant a low P/E ratio. So we might expect a relatively low P/E.
How Does CI Resources’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. We can see in the image below that the average P/E (10.9) for companies in the metals and mining industry is higher than CI Resources’s P/E.
CI Resources’s P/E tells us that market participants think it will not fare as well as its peers in the same industry. Many investors like to buy stocks when the market is pessimistic about their prospects. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The ‘Price’ in P/E reflects the market capitalization of the company. That means it doesn’t take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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).
How Does CI Resources’s Debt Impact Its P/E Ratio?
The extra options and safety that comes with CI Resources’s AU$45m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.