Here's What Prime People Plc's (LON:PRP) P/E Ratio Is Telling Us

This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll look at Prime People Plc's (LON:PRP) P/E ratio and reflect on what it tells us about the company's share price. What is Prime People's P/E ratio? Well, based on the last twelve months it is 7.47. That is equivalent to an earnings yield of about 13.4%.

View our latest analysis for Prime People

How Do You Calculate A P/E Ratio?

The formula for P/E is:

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

Or for Prime People:

P/E of 7.47 = £0.92 ÷ £0.12 (Based on the trailing twelve months to September 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that buyers have to pay a higher price for each £1 the company has earned over the last year. That isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.

How Does Prime People's P/E Ratio Compare To Its Peers?

One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. If you look at the image below, you can see Prime People has a lower P/E than the average (21.4) in the professional services industry classification.

Its relatively low P/E ratio indicates that Prime People 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. You should delve deeper. I like to check if company insiders have been buying or selling.

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 unless the share price increases, the P/E will reduce in a few years. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

Prime People's earnings per share fell by 22% in the last twelve months. But over the longer term (5 years) earnings per share have increased by 5.6%.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

Don't forget that the P/E ratio considers market capitalization. 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 investing in growth. That means taking on debt (or spending its cash).

While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.

How Does Prime People's Debt Impact Its P/E Ratio?

With net cash of UK£3.0m, Prime People has a very strong balance sheet, which may be important for its business. Having said that, at 27% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.

The Bottom Line On Prime People's P/E Ratio

Prime People's P/E is 7.5 which is below average (17.2) in the GB market. The recent drop in earnings per share would almost certainly temper expectations, the healthy balance sheet means the company retains potential for future growth. If that occurs, the current low P/E could prove to be temporary.

Investors should be looking to buy stocks that the market is wrong about. 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. We don't have analyst forecasts, but shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.

Of course you might be able to find a better stock than Prime People. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.

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.