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 Cambria Automobiles plc’s (LON:CAMB) P/E ratio to inform your assessment of the investment opportunity. Cambria Automobiles has a P/E ratio of 7.22, based on the last twelve months. That means that at current prices, buyers pay £7.22 for every £1 in trailing yearly profits.

View our latest analysis for Cambria Automobiles

How Do You Calculate A P/E Ratio?

The formula for P/E is:

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

Or for Cambria Automobiles:

P/E of 7.22 = £0.53 ÷ £0.073 (Based on the trailing twelve months to August 2018.)

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 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 Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the ‘E’ will be higher. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.

Cambria Automobiles saw earnings per share decrease by 21% last year. But EPS is up 17% over the last 5 years.

How Does Cambria Automobiles’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 Cambria Automobiles has a lower P/E than the average (11.2) P/E for companies in the specialty retail industry.

This suggests that market participants think Cambria Automobiles will underperform other companies in its industry. 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.

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. That means it doesn’t take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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.

Is Debt Impacting Cambria Automobiles’s P/E?

Net debt totals 90% of Cambria Automobiles’s market cap. This is a reasonably significant level of debt — all else being equal you’d expect a much lower P/E than if it had net cash.

The Verdict On Cambria Automobiles’s P/E Ratio

Cambria Automobiles trades on a P/E ratio of 7.2, which is below the GB market average of 14.9. The P/E reflects market pessimism that probably arises from the lack of recent EPS growth, paired with significant leverage.

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

But note: Cambria Automobiles may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio 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.