Do You Know What Fiat Chrysler Automobiles N.V.'s (BIT:FCA) P/E Ratio Means?

This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll look at Fiat Chrysler Automobiles N.V.'s (BIT:FCA) P/E ratio and reflect on what it tells us about the company's share price. Fiat Chrysler Automobiles has a P/E ratio of 6.19, based on the last twelve months. That is equivalent to an earnings yield of about 16.1%.

View our latest analysis for Fiat Chrysler Automobiles

How Do I Calculate Fiat Chrysler Automobiles's Price To Earnings Ratio?

The formula for price to earnings is:

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

Or for Fiat Chrysler Automobiles:

P/E of 6.19 = €11.81 ÷ €1.91 (Based on the trailing twelve months to June 2019.)

Is A High P/E 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. 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.

Does Fiat Chrysler Automobiles Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio indicates whether the market has higher or lower expectations of a company. If you look at the image below, you can see Fiat Chrysler Automobiles has a lower P/E than the average (8.5) in the auto industry classification.

Fiat Chrysler Automobiles's P/E tells us that market participants think it will not fare as well as its peers in the same 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.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the 'E' increases, over time. That means even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

Fiat Chrysler Automobiles saw earnings per share decrease by 7.8% last year. But over the longer term (5 years) earnings per share have increased by 23%.

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. 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.

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.

So What Does Fiat Chrysler Automobiles's Balance Sheet Tell Us?

With net cash of €2.5b, Fiat Chrysler Automobiles has a very strong balance sheet, which may be important for its business. Having said that, at 13% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.

The Verdict On Fiat Chrysler Automobiles's P/E Ratio

Fiat Chrysler Automobiles trades on a P/E ratio of 6.2, which is below the IT market average of 16.8. The recent drop in earnings per share would almost certainly temper expectations, the relatively strong balance sheet will allow the company time to invest in growth. If it achieves that, then there's real potential that the low P/E could eventually indicate undervaluation.

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 visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.

You might be able to find a better buy than Fiat Chrysler Automobiles. 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).

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.