Is AJ Bell PLC’s (LON:AJB) P/E Ratio Really That Good?

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 AJ Bell PLC’s (LON:AJB) P/E ratio could help you assess the value on offer. AJ Bell has a price to earnings ratio of 50.3, based on the last twelve months of data. That is equivalent to an earnings yield of about 1.9%. View our latest analysis for AJ Bell

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 AJ Bell: P/E of 50.3 = £2.92 ÷ £0.058 (This is based on the earnings for the twelve months to September 2018, but using AJ Bell’s latest shares on issue figure following its recent IPO.)

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

P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the ‘E’ increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers. Notably, AJ Bell grew its earnings by a whopping 29% in the last year. I’d therefore be a little surprised if its P/E ratio was not relatively high.

How Does AJ Bell’s P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. The image below shows that AJ Bell has a higher P/E than the average (21) P/E for companies in the capital markets industry. AJ Bell’s P/E tells us that market participants think it might fare better than 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. That means it doesn’t take debt or cash into account. 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.

How Does AJ Bell’s Debt Impact Its P/E Ratio?

Since AJ Bell holds net cash of UK£49m, it can spend on growth, possibly justifying a higher P/E ratio than otherwise.

The Bottom Line On AJ Bell’s P/E Ratio

AJ Bell’s P/E is 50.3 which is above average (15.9) in the Great Britain market. The net cash position gives plenty of options to the business, and the recent improvement in EPS is good to see. The high P/E ratio implies the market is quite optimistic. Since analysts are predicting growth will continue, one might expect to see this high P/E, so it may be worth looking to see if growth can live up to expectations. Investors have an opportunity when market expectations about a stock are wrong. If the market is overestimating a company, investors could be stung if the company falls short of expectations. This free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold. But note: AJ Bell 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.