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 Fuller, Smith & Turner P.L.C.'s (LON:FSTA) P/E ratio could help you assess the value on offer. Looking at earnings over the last twelve months, Fuller Smith & Turner has a P/E ratio of 30.28. That corresponds to an earnings yield of approximately 3.3%.

Check out our latest analysis for Fuller Smith & Turner

How Do I Calculate A Price To Earnings Ratio?

The formula for P/E is:

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

Or for Fuller Smith & Turner:

P/E of 30.28 = £6.830 ÷ £0.226 (Based on the year to September 2019.)

(Note: the above calculation results may not be precise due to rounding.)

Is A High P/E Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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 Does Fuller Smith & Turner's P/E Ratio Compare To Its Peers?

The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that Fuller Smith & Turner has a higher P/E than the average (17.4) P/E for companies in the hospitality industry.

Fuller Smith & Turner's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Clearly the market expects growth, but it isn't guaranteed. 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. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.

Fuller Smith & Turner's earnings per share fell by 44% in the last twelve months. And it has shrunk its earnings per share by 14% per year over the last five years. This growth rate might warrant a below average P/E ratio.

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

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. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its 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).

Is Debt Impacting Fuller Smith & Turner's P/E?

Fuller Smith & Turner has net debt worth just 6.7% of its market capitalization. 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 Bottom Line On Fuller Smith & Turner's P/E Ratio

Fuller Smith & Turner has a P/E of 30.3. That's higher than the average in its market, which is 14.1. With a bit of debt, but a lack of recent growth, it's safe to say the market is expecting improved profit performance from the company, in the next few years.

Investors have an opportunity when market expectations about a stock are wrong. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

You might be able to find a better buy than Fuller Smith & Turner. 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).

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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.