This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll look at Heartland Group Holdings Limited's (NZSE:HGH) P/E ratio and reflect on what it tells us about the company's share price. Based on the last twelve months, Heartland Group Holdings's P/E ratio is 15.60. That means that at current prices, buyers pay NZ$15.60 for every NZ$1 in trailing yearly profits.
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Heartland Group Holdings:
P/E of 15.60 = NZ$1.72 ÷ NZ$0.11 (Based on the trailing twelve months 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. 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 Heartland Group Holdings Have A Relatively High Or Low P/E For Its Industry?
We can get an indication of market expectations by looking at the P/E ratio. You can see in the image below that the average P/E (11.3) for companies in the banks industry is lower than Heartland Group Holdings's P/E.
Heartland Group Holdings's P/E tells us that market participants think the company will perform better than its industry peers, going forward. 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.
How Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. That means unless the share price falls, the P/E will increase in a few years. Then, a higher P/E might scare off shareholders, pushing the share price down.
It's great to see that Heartland Group Holdings grew EPS by 16% in the last year. And it has bolstered its earnings per share by 4.7% per year over the last five years. So one might expect an above average P/E ratio. Unfortunately, earnings per share are down 1.2% a year, over 3 years.
Remember: P/E Ratios Don't Consider The Balance Sheet
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 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.
How Does Heartland Group Holdings's Debt Impact Its P/E Ratio?
The extra options and safety that comes with Heartland Group Holdings's NZ$57m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Verdict On Heartland Group Holdings's P/E Ratio
Heartland Group Holdings has a P/E of 15.6. That's below the average in the NZ market, which is 20.0. The net cash position gives plenty of options to the business, and the recent improvement in EPS is good to see. The below average P/E ratio suggests that market participants don't believe the strong growth will continue. Since analysts are predicting growth will continue, one might expect to see a higher P/E so it may be worth looking closer
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.
If you spot an error that warrants correction, please contact the editor at email@example.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.