Yahoo Finance Is Spirent Communications plc's (LON:SPT) High P/E Ratio A Problem For Investors?
The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we'll show how Spirent Communications plc's (LON:SPT) P/E ratio could help you assess the value on offer. What is Spirent Communications's P/E ratio? Well, based on the last twelve months it is 25.77. That is equivalent to an earnings yield of about 3.9%.
Check out our latest analysis for Spirent Communications
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)
Or for Spirent Communications:
P/E of 25.77 = £2.45 (Note: this is the share price in the reporting currency, namely, USD ) ÷ £0.09 (Based on the year to June 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 Spirent Communications Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that Spirent Communications has a higher P/E than the average (14.9) P/E for companies in the communications industry.
Its relatively high P/E ratio indicates that Spirent Communications shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn't guaranteed. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. Earnings growth means that in the future the 'E' will be higher. And in that case, the P/E ratio itself will drop rather quickly. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
In the last year, Spirent Communications grew EPS like Taylor Swift grew her fan base back in 2010; the 80% gain was both fast and well deserved. And earnings per share have improved by 55% annually, over the last three years. So we'd absolutely expect it to have a relatively high P/E ratio.
Remember: P/E Ratios Don't Consider The Balance Sheet
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. That means it doesn't take debt or cash into account. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
So What Does Spirent Communications's Balance Sheet Tell Us?
Spirent Communications has net cash of US$142m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Verdict On Spirent Communications's P/E Ratio
Spirent Communications's P/E is 25.8 which is above average (16.0) in its market. The excess cash it carries is the gravy on top its fast EPS growth. To us, this is the sort of company that we would expect to carry an above average price tag (relative to earnings).
Investors have an opportunity when market expectations about a stock are wrong. 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. 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.
But note: Spirent Communications may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio 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.
