The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll look at Crest Nicholson Holdings plc's (LON:CRST) P/E ratio and reflect on what it tells us about the company's share price. Looking at earnings over the last twelve months, Crest Nicholson Holdings has a P/E ratio of 6.94. That corresponds to an earnings yield of approximately 14.4%.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Crest Nicholson Holdings:
P/E of 6.94 = £3.68 ÷ £0.53 (Based on the year to April 2019.)
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. That isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.
Does Crest Nicholson Holdings 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. The image below shows that Crest Nicholson Holdings has a lower P/E than the average (9.8) P/E for companies in the consumer durables industry.
This suggests that market participants think Crest Nicholson Holdings will underperform other companies in its industry. Since the market seems unimpressed with Crest Nicholson Holdings, it's quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
How Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
Crest Nicholson Holdings saw earnings per share decrease by 18% last year. But EPS is up 11% over the last 5 years.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. Thus, the metric does not reflect cash or debt held by the company. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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.
Crest Nicholson Holdings's Balance Sheet
Net debt totals just 7.0% of Crest Nicholson Holdings's 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 Bottom Line On Crest Nicholson Holdings's P/E Ratio
Crest Nicholson Holdings's P/E is 6.9 which is below average (16.0) in the GB market. The debt levels are not a major concern, but the lack of EPS growth is likely weighing on sentiment.
When the market is wrong about a stock, it gives savvy investors an opportunity. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
You might be able to find a better buy than Crest Nicholson Holdings. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.