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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll look at Ferrexpo Plc's (LON:FXPO) P/E ratio and reflect on what it tells us about the company's share price. Based on the last twelve months, Ferrexpo's P/E ratio is 5.81. That means that at current prices, buyers pay £5.81 for every £1 in trailing yearly profits.
Check out our latest analysis for Ferrexpo
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)
Or for Ferrexpo:
P/E of 5.81 = $3.31 (Note: this is the share price in the reporting currency, namely, USD ) ÷ $0.57 (Based on the trailing twelve months to December 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. 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 Ferrexpo Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. The image below shows that Ferrexpo has a lower P/E than the average (10.4) P/E for companies in the metals and mining industry.
Its relatively low P/E ratio indicates that Ferrexpo shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. 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. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. That means unless the share price increases, the P/E will reduce in a few years. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Ferrexpo's earnings per share fell by 15% in the last twelve months. But it has grown its earnings per share by 4.9% per year over the last five years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. Thus, the metric does not reflect cash or debt held by the company. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.