The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to Team17 Group PLC's (LON:TM17), to help you decide if the stock is worth further research. What is Team17 Group's P/E ratio? Well, based on the last twelve months it is 43.71. In other words, at today's prices, investors are paying £43.71 for every £1 in prior year profit.
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Team17 Group:
P/E of 43.71 = £2.66 ÷ £0.061 (Based on the trailing twelve months to December 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each £1 the company has earned over the last year. 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 Team17 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. The image below shows that Team17 Group has a higher P/E than the average (30.9) P/E for companies in the entertainment industry.
Its relatively high P/E ratio indicates that Team17 Group shareholders think it will perform better than other companies in its industry classification. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
If earnings fall then in the future the 'E' will be lower. 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.
It's nice to see that Team17 Group grew EPS by a stonking 40% in the last year. Unfortunately, earnings per share are down 87% a year, over 3 years.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
Don't forget that the P/E ratio considers market capitalization. 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.
How Does Team17 Group's Debt Impact Its P/E Ratio?
Since Team17 Group holds net cash of UK£24m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Bottom Line On Team17 Group's P/E Ratio
Team17 Group trades on a P/E ratio of 43.7, which is above its market average of 15.8. The excess cash it carries is the gravy on top its fast EPS growth. So based on this analysis we'd expect Team17 Group to have a high P/E ratio.
Investors should be looking to buy stocks that the market is wrong about. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
Of course you might be able to find a better stock than Team17 Group. So you may wish to see this free collection of other companies that have grown earnings strongly.
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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.