Yahoo Finance Here's What Pearson plc's (LON:PSON) P/E Ratio Is Telling Us
This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to Pearson plc's (LON:PSON), to help you decide if the stock is worth further research. What is Pearson's P/E ratio? Well, based on the last twelve months it is 16.52. That corresponds to an earnings yield of approximately 6.1%.
Check out our latest analysis for Pearson
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 Pearson:
P/E of 16.52 = GBP5.61 ÷ GBP0.34 (Based on the year to December 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each GBP1 of company 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 Pearson Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. We can see in the image below that the average P/E (23.7) for companies in the media industry is higher than Pearson's P/E.
This suggests that market participants think Pearson will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. When earnings grow, the 'E' increases, over time. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.
Pearson saw earnings per share decrease by 55% last year. But it has grown its earnings per share by 6.6% per year over the last five 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 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.
Pearson's Balance Sheet
Net debt totals just 10.0% of Pearson's market cap. The market might award it a higher P/E ratio if it had net cash, but its unlikely this low level of net borrowing is having a big impact on the P/E multiple.
The Bottom Line On Pearson's P/E Ratio
Pearson has a P/E of 16.5. That's below the average in the GB market, which is 18.6. With only modest debt, it's likely the lack of EPS growth at least partially explains the pessimism implied by the P/E ratio.
Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. 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.
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.
