Yahoo Finance Why Rotork plc’s (LON:ROR) High P/E Ratio Isn’t Necessarily A Bad Thing
This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we’ll show how Rotork plc’s (LON:ROR) P/E ratio could help you assess the value on offer. Rotork has a P/E ratio of 27.67, based on the last twelve months. In other words, at today’s prices, investors are paying £27.67 for every £1 in prior year profit.
Check out our latest analysis for Rotork
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Rotork:
P/E of 27.67 = £2.91 ÷ £0.10 (Based on the year to December 2018.)
Is A High P/E Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. 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.
Notably, Rotork grew EPS by a whopping 64% in the last year. And earnings per share have improved by 2.4% annually, over the last three years. I’d therefore be a little surprised if its P/E ratio was not relatively high. But earnings per share are down 10% per year over the last five years.
How Does Rotork’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. You can see in the image below that the average P/E (17.6) for companies in the machinery industry is lower than Rotork’s P/E.
Its relatively high P/E ratio indicates that Rotork 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 always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
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. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
How Does Rotork’s Debt Impact Its P/E Ratio?
Since Rotork holds net cash of UK£44m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Verdict On Rotork’s P/E Ratio
Rotork trades on a P/E ratio of 27.7, which is above the GB market average of 16. Its net cash position supports a higher P/E ratio, as does its solid recent earnings growth. Therefore it seems reasonable that the market would have relatively high expectations of the company
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.
Of course you might be able to find a better stock than Rotork. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.
