This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we’ll show how Olam International Limited’s (SGX:O32) P/E ratio could help you assess the value on offer. Olam International has a price to earnings ratio of 11.81, based on the last twelve months. That is equivalent to an earnings yield of about 8.5%.
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How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Olam International:
P/E of 11.81 = SGD1.81 ÷ SGD0.15 (Based on the trailing twelve months to September 2018.)
Is A High P/E Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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
P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the ‘E’ increases, over time. That means unless the share price increases, the P/E will reduce in a few years. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
It’s great to see that Olam International grew EPS by 16% in the last year. And it has improved its earnings per share by 65% per year over the last three years. This could arguably justify a relatively high P/E ratio. But earnings per share are down 7.4% per year over the last five years.
How Does Olam International’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. We can see in the image below that the average P/E (23.6) for companies in the consumer retailing industry is higher than Olam International’s P/E.
Its relatively low P/E ratio indicates that Olam International shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Olam International, it’s quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.