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 Transurban Group’s (ASX:TCL) P/E ratio could help you assess the value on offer. Based on the last twelve months, Transurban Group’s P/E ratio is 53.34. In other words, at today’s prices, investors are paying A$53.34 for every A$1 in prior year profit.
How Do I Calculate Transurban Group’s Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Transurban Group:
P/E of 53.34 = A$12.1 ÷ A$0.23 (Based on the year to June 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. All else being equal, it’s better to pay a low price — but as Warren Buffett said, ‘It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.’
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. Then, a lower P/E should attract more buyers, pushing the share price up.
Transurban Group increased earnings per share by a whopping 94% last year. And its annual EPS growth rate over 5 years is 19%. With that performance, I would expect it to have an above average P/E ratio.
How Does Transurban Group’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Transurban Group has a higher P/E than the average (22.2) P/E for companies in the infrastructure industry.
Its relatively high P/E ratio indicates that Transurban 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.
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. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
Is Debt Impacting Transurban Group’s P/E?
Net debt totals 45% of Transurban Group’s market cap. This is a reasonably significant level of debt — all else being equal you’d expect a much lower P/E than if it had net cash.
The Bottom Line On Transurban Group’s P/E Ratio
Transurban Group trades on a P/E ratio of 53.3, which is multiples above the AU market average of 15.2. While the company does use modest debt, its recent earnings growth is impressive. So it does not seem strange that the P/E is above average.
Investors have an opportunity when market expectations about a stock are wrong. 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 find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E 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 firstname.lastname@example.org.