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Why Sylvania Platinum Limited's (LON:SLP) 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). We'll apply a basic P/E ratio analysis to Sylvania Platinum Limited's (LON:SLP), to help you decide if the stock is worth further research. Looking at earnings over the last twelve months, Sylvania Platinum has a P/E ratio of 9.26. In other words, at today's prices, investors are paying £9.26 for every £1 in prior year profit.

View our latest analysis for Sylvania Platinum

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)

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Or for Sylvania Platinum:

P/E of 9.26 = £0.48 (Note: this is the share price in the reporting currency, namely, USD ) ÷ £0.05 (Based on the trailing twelve months to September 2019.)

Is A High Price-to-Earnings 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 Does Sylvania Platinum's P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. As you can see below Sylvania Platinum has a P/E ratio that is fairly close for the average for the metals and mining industry, which is 8.9.

AIM:SLP Price Estimation Relative to Market, December 12th 2019
AIM:SLP Price Estimation Relative to Market, December 12th 2019

Its P/E ratio suggests that Sylvania Platinum shareholders think that in the future it will perform about the same as other companies in its industry classification. The company could surprise by performing better than average, in the future. I would further inform my view by checking insider buying and selling., among other things.

How Growth Rates Impact P/E Ratios

Probably the most important factor in determining what P/E a company trades on is the earnings growth. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. That means even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

Sylvania Platinum increased earnings per share by a whopping 26% last year. And earnings per share have improved by 37% annually, over the last three years. With that performance, I would expect it to have an above average 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. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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.

Is Debt Impacting Sylvania Platinum's P/E?

With net cash of US$22m, Sylvania Platinum has a very strong balance sheet, which may be important for its business. Having said that, at 16% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.

The Bottom Line On Sylvania Platinum's P/E Ratio

Sylvania Platinum's P/E is 9.3 which is below average (17.2) in the GB market. Not only should the net cash position reduce risk, but the recent growth has been impressive. One might conclude that the market is a bit pessimistic, given the low P/E ratio.

Investors should be looking to buy stocks that the market is wrong about. 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 report on the analyst consensus forecasts could help you make a master move on this stock.

Of course you might be able to find a better stock than Sylvania Platinum. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.