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Here’s How P/E Ratios Can Help Us Understand Skellerup Holdings Limited (NZSE:SKL)

This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll look at Skellerup Holdings Limited’s (NZSE:SKL) P/E ratio and reflect on what it tells us about the company’s share price. Skellerup Holdings has a price to earnings ratio of 14.35, based on the last twelve months. In other words, at today’s prices, investors are paying NZ$14.35 for every NZ$1 in prior year profit.

See our latest analysis for Skellerup Holdings

How Do You Calculate A P/E Ratio?

The formula for P/E is:

Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)

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Or for Skellerup Holdings:

P/E of 14.35 = NZ$2.03 ÷ NZ$0.14 (Based on the trailing twelve months to June 2018.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each NZ$1 of company earnings. 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. When earnings grow, the ‘E’ increases, over time. That means even if the current P/E is high, it will reduce over time if the share price stays flat. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Skellerup Holdings increased earnings per share by an impressive 23% over the last twelve months. And earnings per share have improved by 7.4% annually, over the last three years. So one might expect an above average P/E ratio. But earnings per share are down 4.2% per year over the last five years.

How Does Skellerup Holdings’s P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. If you look at the image below, you can see Skellerup Holdings has a lower P/E than the average (16.9) in the machinery industry classification.

NZSE:SKL PE PEG Gauge November 24th 18
NZSE:SKL PE PEG Gauge November 24th 18

Its relatively low P/E ratio indicates that Skellerup Holdings shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.

Remember: P/E Ratios Don’t Consider The Balance Sheet

The ‘Price’ in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. Theoretically, a business can improve its earnings (and produce a lower P/E in the future), by taking on debt (or spending its remaining cash).

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).

Skellerup Holdings’s Balance Sheet

Net debt totals just 7.8% of Skellerup Holdings’s market cap. So it doesn’t have as many options as it would with net cash, but its debt would not have much of an impact on its P/E ratio.

The Verdict On Skellerup Holdings’s P/E Ratio

Skellerup Holdings’s P/E is 14.3 which is below average (15.8) in the NZ market. The company hasn’t stretched its balance sheet, and earnings growth was good last year. The low P/E ratio suggests current market expectations are muted, implying these levels of growth will not continue. Given analysts are expecting further growth, one might have expected a higher P/E ratio. That may be worth further research.

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 report on the analyst consensus forecasts could help you make a master move on this stock.

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.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.