This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll look at CML Group Limited’s (ASX:CGR) P/E ratio and reflect on what it tells us about the company’s share price. CML Group has a price to earnings ratio of 24.81, based on the last twelve months. That corresponds to an earnings yield of approximately 4.0%.
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 CML Group:
P/E of 24.81 = A$0.46 ÷ A$0.019 (Based on the year to June 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 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. 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. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
CML Group shrunk earnings per share by 1.7% last year. But over the longer term (5 years) earnings per share have increased by 16%.
How Does CML Group’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. As you can see below, CML Group has a higher P/E than the average company (21.6) in the professional services industry.
CML Group’s P/E tells us that market participants think the company will perform better than its industry peers, going forward. Clearly the market expects growth, but it isn’t guaranteed. So further research is always essential. I often monitor director buying and selling.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don’t forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. 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).
CML Group’s Balance Sheet
CML Group’s net debt is considerable, at 123% of its market cap. This level of debt justifies a relatively low P/E, so remain cognizant of the debt, if you’re comparing it to other stocks.
The Verdict On CML Group’s P/E Ratio
CML Group has a P/E of 24.8. That’s higher than the average in the AU market, which is 15.2. With relatively high debt, and no earnings per share growth over twelve months, it’s safe to say the market believes the company will improve its earnings growth in the future.
When the market is wrong about a stock, it gives savvy investors an opportunity. As value investor Benjamin Graham famously said, ‘In the short run, the market is a voting machine but in the long run, it is a weighing machine.’ So this free report on the analyst consensus forecasts could help you make a master move on this stock.
But note: CML 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).
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.