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 OUE Limited's (SGX:LJ3) P/E ratio to inform your assessment of the investment opportunity. OUE has a P/E ratio of 7.16, based on the last twelve months. That corresponds to an earnings yield of approximately 14.0%.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for OUE:
P/E of 7.16 = SGD1.49 ÷ SGD0.21 (Based on the year to September 2019.)
Is A High P/E Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. 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.
Does OUE Have A Relatively High Or Low P/E For Its Industry?
We can get an indication of market expectations by looking at the P/E ratio. If you look at the image below, you can see OUE has a lower P/E than the average (10.1) in the real estate industry classification.
Its relatively low P/E ratio indicates that OUE shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. You should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
When earnings fall, the 'E' decreases, over time. That means even if the current P/E is low, it will increase over time if the share price stays flat. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
OUE's 153% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. Regrettably, the longer term performance is poor, with EPS down 27% per year over 5 years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. So it won't reflect the advantage of cash, or disadvantage of debt. 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).
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.
OUE's Balance Sheet
OUE has net debt worth a very significant 288% of its market capitalization. This level of debt justifies a relatively low P/E, so remain cognizant of the debt, if you're comparing it to other stocks.
The Verdict On OUE's P/E Ratio
OUE has a P/E of 7.2. That's below the average in the SG market, which is 13.3. The company has a meaningful amount of debt on the balance sheet, but that should not eclipse the solid earnings growth. The low P/E ratio suggests current market expectations are muted, implying these levels of growth will not continue.
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. We don't have analyst forecasts, but you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.
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.
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.
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.