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Is QinetiQ Group plc's (LON:QQ.) P/E Ratio Really That Good?

Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll apply a basic P/E ratio analysis to QinetiQ Group plc's (LON:QQ.), to help you decide if the stock is worth further research. Looking at earnings over the last twelve months, QinetiQ Group has a P/E ratio of 14.31. That means that at current prices, buyers pay £14.31 for every £1 in trailing yearly profits.

Check out our latest analysis for QinetiQ Group

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)

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Or for QinetiQ Group:

P/E of 14.31 = £2.88 ÷ £0.20 (Based on the trailing twelve months to March 2019.)

Is A High P/E Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each £1 of company earnings. That isn't necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.

Does QinetiQ 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 QinetiQ Group has a lower P/E than the average (24.1) P/E for companies in the aerospace & defense industry.

LSE:QQ. Price Estimation Relative to Market, September 27th 2019
LSE:QQ. Price Estimation Relative to Market, September 27th 2019

Its relatively low P/E ratio indicates that QinetiQ Group shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with QinetiQ Group, it's quite possible it could surprise on the upside. 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

P/E ratios primarily reflect market expectations around earnings growth rates. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. Then, a lower P/E should attract more buyers, pushing the share price up.

QinetiQ Group's earnings per share fell by 18% in the last twelve months. But over the longer term (5 years) earnings per share have increased by 14%.

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.

Is Debt Impacting QinetiQ Group's P/E?

QinetiQ Group has net cash of UK£191m. This is fairly high at 12% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.

The Verdict On QinetiQ Group's P/E Ratio

QinetiQ Group has a P/E of 14.3. That's below the average in the GB market, which is 16.0. The recent drop in earnings per share would make investors cautious, the healthy balance sheet means the company retains potential for future growth. If that occurs, the current low P/E could prove to be temporary.

Investors have an opportunity when market expectations about a stock are wrong. 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 visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.

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.

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.

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. Thank you for reading.