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Despite Its High P/E Ratio, Is TP ICAP plc (LON:TCAP) Still Undervalued?

This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll show how you can use TP ICAP plc's (LON:TCAP) P/E ratio to inform your assessment of the investment opportunity. TP ICAP has a price to earnings ratio of 24.39, based on the last twelve months. That is equivalent to an earnings yield of about 4.1%.

See our latest analysis for TP ICAP

How Do I Calculate A Price To Earnings Ratio?

The formula for P/E is:

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

Or for TP ICAP:

P/E of 24.39 = £3.70 ÷ £0.15 (Based on the year to June 2019.)

Is A High Price-to-Earnings Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing 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.

Does TP ICAP Have A Relatively High Or Low P/E For Its Industry?

One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. You can see in the image below that the average P/E (18.9) for companies in the capital markets industry is lower than TP ICAP's P/E.

LSE:TCAP Price Estimation Relative to Market, November 27th 2019
LSE:TCAP Price Estimation Relative to Market, November 27th 2019

Its relatively high P/E ratio indicates that TP ICAP shareholders think it will perform better than other companies in its industry classification. The market is optimistic about the future, but that doesn't guarantee future growth. So further research is always essential. I often monitor director buying and selling.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the 'E' will be higher. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.

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In the last year, TP ICAP grew EPS like Taylor Swift grew her fan base back in 2010; the 95% gain was both fast and well deserved.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

Don't forget that the P/E ratio considers market capitalization. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).

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.

So What Does TP ICAP's Balance Sheet Tell Us?

TP ICAP's net debt is 3.9% of its market cap. It would probably trade on a higher P/E ratio if it had a lot of cash, but I doubt it is having a big impact.

The Verdict On TP ICAP's P/E Ratio

TP ICAP's P/E is 24.4 which is above average (17.1) in its market. Its debt levels do not imperil its balance sheet and its EPS growth is very healthy indeed. So to be frank we are not surprised it has a high P/E ratio.

Investors should be looking to buy stocks that the market is wrong about. 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.

Of course you might be able to find a better stock than TP ICAP. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.

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. Thank you for reading.