In This Article:
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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 First Derivatives plc's (LON:FDP) P/E ratio and reflect on what it tells us about the company's share price. First Derivatives has a price to earnings ratio of 66.86, based on the last twelve months. That means that at current prices, buyers pay £66.86 for every £1 in trailing yearly profits.
Check out our latest analysis for First Derivatives
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 First Derivatives:
P/E of 66.86 = £34 ÷ £0.51 (Based on the trailing twelve months to February 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each £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
Earnings growth rates have a big influence on P/E ratios. When earnings grow, the 'E' increases, over time. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.
First Derivatives increased earnings per share by a whopping 26% last year. And earnings per share have improved by 8.1% annually, over the last five years. With that performance, I would expect it to have an above average P/E ratio.
Does First Derivatives Have A Relatively High Or Low P/E For Its Industry?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. You can see in the image below that the average P/E (31.4) for companies in the software industry is lower than First Derivatives's P/E.
That means that the market expects First Derivatives will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. So further research is always essential. I often monitor director buying and selling.
Remember: P/E Ratios Don't Consider The Balance Sheet
The 'Price' in P/E reflects the market capitalization of the company. So it won't reflect the advantage of cash, or disadvantage of debt. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.