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Do You Like The Citadel Group Limited (ASX:CGL) At This P/E Ratio?

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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll look at The Citadel Group Limited's (ASX:CGL) P/E ratio and reflect on what it tells us about the company's share price. What is Citadel Group's P/E ratio? Well, based on the last twelve months it is 13.02. That means that at current prices, buyers pay A$13.02 for every A$1 in trailing yearly profits.

Check out our latest analysis for Citadel Group

How Do You Calculate A P/E Ratio?

The formula for P/E is:

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Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)

Or for Citadel Group:

P/E of 13.02 = A$4.29 ÷ A$0.33 (Based on the year to December 2018.)

Is A High P/E Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each A$1 of company earnings. 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. 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. Then, a lower P/E should attract more buyers, pushing the share price up.

Notably, Citadel Group grew EPS by a whopping 26% in the last year. And its annual EPS growth rate over 5 years is 22%. I'd therefore be a little surprised if its P/E ratio was not relatively high.

How Does Citadel Group's P/E Ratio Compare To Its Peers?

One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. We can see in the image below that the average P/E (16.3) for companies in the it industry is higher than Citadel Group's P/E.

ASX:CGL Price Estimation Relative to Market, June 13th 2019
ASX:CGL Price Estimation Relative to Market, June 13th 2019

Its relatively low P/E ratio indicates that Citadel Group shareholders think it will struggle to do as well as other companies in its industry classification. Many investors like to buy stocks when the market is pessimistic about their prospects. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.

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. That means it doesn't take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.

Citadel Group's Balance Sheet

The extra options and safety that comes with Citadel Group's AU$376k net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.

The Bottom Line On Citadel Group's P/E Ratio

Citadel Group's P/E is 13 which is below average (16.3) in the AU market. Not only should the net cash position reduce risk, but the recent growth has been impressive. One might conclude that the market is a bit pessimistic, given the low P/E ratio.

Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

But note: Citadel Group may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.