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 G5 Entertainment AB (publ)’s (STO:G5EN) P/E ratio could help you assess the value on offer. G5 Entertainment has a P/E ratio of 18.23, based on the last twelve months. That is equivalent to an earnings yield of about 5.5%.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for G5 Entertainment:
P/E of 18.23 = SEK270.6 ÷ SEK14.84 (Based on the year to June 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 SEK1 the company has earned over the last year. That isn’t a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business’s prospects, relative to stocks with a lower P/E.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. When earnings grow, the ‘E’ increases, over time. That means even if the current P/E is high, it will reduce over time if the share price stays flat. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Notably, G5 Entertainment grew EPS by a whopping 97% in the last year. And its annual EPS growth rate over 5 years is 62%. So we’d generally expect it to have a relatively high P/E ratio.
How Does G5 Entertainment’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. If you look at the image below, you can see G5 Entertainment has a lower P/E than the average (22.6) in the entertainment industry classification.
G5 Entertainment’s P/E tells us that market participants think it will not fare as well as its peers in the same industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
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. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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).
How Does G5 Entertainment’s Debt Impact Its P/E Ratio?
The extra options and safety that comes with G5 Entertainment’s kr108m 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 G5 Entertainment’s P/E Ratio
G5 Entertainment trades on a P/E ratio of 18.2, which is above the SE market average of 16.3. Its strong balance sheet gives the company plenty of resources for extra growth, and it has already proven it can grow. So it is not surprising the market is probably extrapolating recent growth well into the future, reflected in the relatively high P/E ratio.
When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
But note: G5 Entertainment 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 email@example.com.