In This Article:
The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we’ll show how Sembcorp Industries Ltd’s (SGX:U96) P/E ratio could help you assess the value on offer. Sembcorp Industries has a P/E ratio of 29.95, based on the last twelve months. That means that at current prices, buyers pay SGD29.95 for every SGD1 in trailing yearly profits.
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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 Sembcorp Industries:
P/E of 29.95 = SGD2.69 ÷ SGD0.090 (Based on the year to September 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each SGD1 the company has earned over the last year. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about 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.
Sembcorp Industries shrunk earnings per share by 57% over the last year. And it has shrunk its earnings per share by 31% per year over the last five years. This growth rate might warrant a below average P/E ratio.
How Does Sembcorp Industries’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. You can see in the image below that the average P/E (30.1) for companies in the industrials industry is roughly the same as Sembcorp Industries’s P/E.
Sembcorp Industries’s P/E tells us that market participants think its prospects are roughly in line with its industry. If the company has better than average prospects, then the market might be underestimating it. I inform my view byby checking management tenure and remuneration, among other things.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
The ‘Price’ in P/E reflects the market capitalization of the company. That means it doesn’t take debt or cash into account. Theoretically, a business can improve its earnings (and produce a lower P/E in the future), by taking on debt (or spending its remaining cash).