This article is written for those who want to get better at using price to earnings ratios (P/E ratios).
To keep it practical, we’ll show how Centamin plc’s (LON:CEY) P/E ratio could help you assess the value on offer.
Based on the last twelve months, Centamin’s P/E ratio is 15.81.
That corresponds to an earnings yield of approximately 6.3%.
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How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)
Or for Centamin:
P/E of 15.81 = $1.54 (Note: this is the share price in the reporting currency, namely, USD ) ÷ $0.097
(Based on the trailing twelve months to September 2018.)
Is A High P/E Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each £1 of company earnings.
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.
When earnings grow, the ‘E’ increases, over time.
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.
Centamin increased earnings per share by an impressive 25% over the last twelve months.
And earnings per share have improved by 9.5% annually, over the last three years.
With that performance, you might expect an above average P/E ratio.
In contrast, EPS has decreased by 1.2%, annually, over 5 years.
How Does Centamin’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company.
You can see in the image below that the average P/E (9.6) for companies in the metals and mining industry is lower than Centamin’s P/E.
Centamin’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 investors should delve deeper. I like to check if company insiders have been buying or selling.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
Don’t forget that the P/E ratio considers market capitalization.
Thus, the metric does not reflect cash or debt held by the company.
Theoretically, a business can improve its earnings (and produce a lower P/E in the future), by taking on debt (or spending its remaining cash).
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
Is Debt Impacting Centamin’s P/E?
The extra options and safety that comes with Centamin’s US$254m 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 Centamin’s P/E Ratio
Centamin trades on a P/E ratio of 15.8, which is fairly close to the GB market average of 15.6.
The balance sheet is healthy, and recent EPS growth impressive, but the P/E implies some caution from the market.
When the market is wrong about a stock, it gives savvy investors an opportunity.
People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated.
So this free report on the analyst consensus forecasts could help you make a master move on this stock.
You might be able to find a better buy than Centamin. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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.