In This Article:
The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll look at Reliance Worldwide Corporation Limited’s (ASX:RWC) P/E ratio and reflect on what it tells us about the company’s share price. Reliance Worldwide has a price to earnings ratio of 36.37, based on the last twelve months. That is equivalent to an earnings yield of about 2.7%.
See our latest analysis for Reliance Worldwide
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 Reliance Worldwide:
P/E of 36.37 = A$4.46 ÷ A$0.12 (Based on the trailing twelve months to June 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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
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. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
Reliance Worldwide shrunk earnings per share by 1.9% last year.
How Does Reliance Worldwide’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Reliance Worldwide has a higher P/E than the average (15) P/E for companies in the building industry.
Reliance Worldwide’s P/E tells us that market participants think the company will perform better than its industry peers, going forward. Shareholders are clearly optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
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.
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).