Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll apply a basic P/E ratio analysis to Valmec Limited's (ASX:VMX), to help you decide if the stock is worth further research. Based on the last twelve months, Valmec's P/E ratio is 10.64. That means that at current prices, buyers pay A$10.64 for every A$1 in trailing yearly profits.
See our latest analysis for Valmec
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Valmec:
P/E of 10.64 = A$0.30 ÷ A$0.028 (Based on the trailing twelve months to June 2019.)
Is A High Price-to-Earnings Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
Does Valmec Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. We can see in the image below that the average P/E (13.7) for companies in the energy services industry is higher than Valmec's P/E.
Valmec's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Valmec, it's quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
Valmec saw earnings per share decrease by 24% last year. But it has grown its earnings per share by 132% per year over the last three years. And it has shrunk its earnings per share by 30% per year over the last five years. This might lead to muted expectations.
Remember: P/E Ratios Don't Consider The Balance Sheet
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. In other words, it does not consider any debt or cash that the company may have on the balance sheet. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.