Yahoo Finance Should We Worry About Spirax-Sarco Engineering plc's (LON:SPX) P/E Ratio?
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Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. To keep it practical, we'll show how Spirax-Sarco Engineering plc's (LON:SPX) P/E ratio could help you assess the value on offer. Spirax-Sarco Engineering has a P/E ratio of 30.75, based on the last twelve months. That is equivalent to an earnings yield of about 3.3%.
See our latest analysis for Spirax-Sarco Engineering
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Spirax-Sarco Engineering:
P/E of 30.75 = £93.2 ÷ £3.03 (Based on the trailing twelve months to December 2018.)
Is A High Price-to-Earnings 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.
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. When earnings grow, the 'E' increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
It's nice to see that Spirax-Sarco Engineering grew EPS by a stonking 41% in the last year. And earnings per share have improved by 17% annually, over the last five years. I'd therefore be a little surprised if its P/E ratio was not relatively high.
How Does Spirax-Sarco Engineering's P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Spirax-Sarco Engineering has a higher P/E than the average (17.9) P/E for companies in the machinery industry.
Its relatively high P/E ratio indicates that Spirax-Sarco Engineering shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. 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
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. So it won't reflect the advantage of cash, or disadvantage of debt. 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.
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 Spirax-Sarco Engineering's P/E?
Spirax-Sarco Engineering has net debt worth just 3.4% of its market capitalization. It would probably trade on a higher P/E ratio if it had a lot of cash, but I doubt it is having a big impact.
The Verdict On Spirax-Sarco Engineering's P/E Ratio
Spirax-Sarco Engineering's P/E is 30.7 which is above average (16.4) in the GB market. The company is not overly constrained by its modest debt levels, and its recent EPS growth is nothing short of stand-out. So on this analysis a high P/E ratio seems reasonable.
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 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 Spirax-Sarco Engineering. 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.
