Should We Worry About Sietel Limited's (ASX:SSL) P/E Ratio?

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 Sietel Limited's (ASX:SSL) P/E ratio could help you assess the value on offer. What is Sietel's P/E ratio? Well, based on the last twelve months it is 41.53. That means that at current prices, buyers pay A$41.53 for every A$1 in trailing yearly profits.

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View our latest analysis for Sietel

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 Sietel:

P/E of 41.53 = A$6.4 ÷ A$0.15 (Based on the trailing twelve months to September 2018.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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

Probably the most important factor in determining what P/E a company trades on is the earnings growth. When earnings grow, the 'E' increases, over time. And in that case, the P/E ratio itself will drop rather quickly. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

Sietel shrunk earnings per share by 9.9% last year. And EPS is down 13% a year, over the last 5 years. So we might expect a relatively low P/E.

How Does Sietel'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 Sietel has a significantly higher P/E than the average (11.5) P/E for companies in the real estate industry.

That means that the market expects Sietel will outperform other companies in its industry. Clearly the market expects growth, but it isn't guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.

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

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. 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 expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.

Sietel's Balance Sheet

Sietel has net cash of AU$2.2m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.

The Verdict On Sietel's P/E Ratio

Sietel trades on a P/E ratio of 41.5, which is above the AU market average of 16.1. Falling earnings per share is probably keeping traditional value investors away, but the net cash position means the company has time to improve: and the high P/E suggests the market thinks it will.

Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. Although we don't have analyst forecasts, you might want to assess this data-rich visualization of earnings, revenue and cash flow.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

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.