The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll look at Infratil Limited’s (NZSE:IFT) P/E ratio and reflect on what it tells us about the company’s share price. Infratil has a P/E ratio of 29.96, based on the last twelve months. That means that at current prices, buyers pay NZ$29.96 for every NZ$1 in trailing yearly profits.
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 Infratil:
P/E of 29.96 = NZ$3.58 ÷ NZ$0.12 (Based on the trailing twelve months to September 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. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.
Infratil increased earnings per share by an impressive 19% over the last twelve months. And it has improved its earnings per share by 70% per year over the last three years. So one might expect an above average P/E ratio. But earnings per share are down 47% per year over the last five years.
How Does Infratil’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. As you can see below Infratil has a P/E ratio that is fairly close for the average for the electric utilities industry, which is 29.9.
Its P/E ratio suggests that Infratil shareholders think that in the future it will perform about the same as other companies in its industry classification. So if Infratil actually outperforms its peers going forward, that should be a positive for the share price. I inform my view byby checking management tenure and remuneration, among other things.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
The ‘Price’ in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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).
How Does Infratil’s Debt Impact Its P/E Ratio?
Infratil’s net debt is considerable, at 125% of its market cap. This is a relatively high level of debt, so the stock probably deserves a relatively low P/E ratio. Keep that in mind when comparing it to other companies.
The Verdict On Infratil’s P/E Ratio
Infratil has a P/E of 30. That’s higher than the average in the NZ market, which is 15.9. It has already proven it can grow earnings, but the debt levels mean it faces some risks. It seems the market believes growth will continue, judging by the P/E ratio.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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 they key to an excellent investment decision.
You might be able to find a better buy than Infratil. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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 firstname.lastname@example.org.