Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. To keep it practical, we'll show how Lok'nStore Group Plc's (LON:LOK) P/E ratio could help you assess the value on offer. Lok'nStore Group has a price to earnings ratio of 37.28, based on the last twelve months. That corresponds to an earnings yield of approximately 2.7%.
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 Lok'nStore Group:
P/E of 37.28 = £5.35 ÷ £0.14 (Based on the trailing twelve months to January 2019.)
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.
Does Lok'nStore Group 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. As you can see below, Lok'nStore Group has a much higher P/E than the average company (11.2) in the real estate industry.
Its relatively high P/E ratio indicates that Lok'nStore Group shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn't guaranteed. So further research is always essential. I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. That means unless the share price falls, the P/E will increase in a few years. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
Notably, Lok'nStore Group grew EPS by a whopping 42% in the last year. And it has bolstered its earnings per share by 17% per year over the last five years. With that performance, I would expect it to have an above average P/E ratio. In contrast, EPS has decreased by 1.6%, annually, over 3 years.
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. 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.
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.
So What Does Lok'nStore Group's Balance Sheet Tell Us?
Net debt totals 20% of Lok'nStore Group's market cap. That's enough debt to impact the P/E ratio a little; so keep it in mind if you're comparing it to companies without debt.
The Verdict On Lok'nStore Group's P/E Ratio
Lok'nStore Group trades on a P/E ratio of 37.3, which is above its market average of 16.7. The company is not overly constrained by its modest debt levels, and its recent EPS growth is nothing short of stand-out. So on this analysis a high P/E ratio seems reasonable.
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 visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
But note: Lok'nStore 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).
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 email@example.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.