Does James Latham plc's (LON:LTHM) P/E Ratio Signal A Buying Opportunity?
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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll show how you can use James Latham plc's (LON:LTHM) P/E ratio to inform your assessment of the investment opportunity. James Latham has a price to earnings ratio of 11.37, based on the last twelve months. In other words, at today's prices, investors are paying £11.37 for every £1 in prior year profit.
View our latest analysis for James Latham
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for James Latham:
P/E of 11.37 = £8.35 ÷ £0.73 (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 £1 of company earnings. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.'
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. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
James Latham increased earnings per share by a whopping 40% last year. And it has bolstered its earnings per share by 20% per year over the last five years. With that performance, I would expect it to have an above average P/E ratio.
How Does James Latham's P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. The image below shows that James Latham has a lower P/E than the average (16.3) P/E for companies in the trade distributors industry.
This suggests that market participants think James Latham will underperform other companies in its industry. Since the market seems unimpressed with James Latham, it's quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.
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. That means it doesn't take debt or cash into account. 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.
How Does James Latham's Debt Impact Its P/E Ratio?
The extra options and safety that comes with James Latham's UK£12m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Bottom Line On James Latham's P/E Ratio
James Latham's P/E is 11.4 which is below average (16.3) in the GB market. It grew its EPS nicely over the last year, and the healthy balance sheet implies there is more potential for growth. The below average P/E ratio suggests that market participants don't believe the strong growth will continue.
Investors have an opportunity when market expectations about a stock are wrong. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. We don't have analyst forecasts, but you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.
Of course you might be able to find a better stock than James Latham. 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.
