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 AB SKF (publ)’s (STO:SKF B) P/E ratio to inform your assessment of the investment opportunity. What is AB SKF’s P/E ratio? Well, based on the last twelve months it is 12.53. That corresponds to an earnings yield of approximately 8.0%.
How Do I Calculate AB SKF’s Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for AB SKF:
P/E of 12.53 = SEK182.45 ÷ SEK14.56 (Based on the trailing twelve months to September 2019.)
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. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
How Does AB SKF’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. We can see in the image below that the average P/E (17.2) for companies in the machinery industry is higher than AB SKF’s P/E.
This suggests that market participants think AB SKF will underperform other companies in its industry.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company’s P/E multiple. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. 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.
AB SKF saw earnings per share decrease by 6.0% last year. But it has grown its earnings per share by 32% per year over the last five years. Shareholders have some reason to be optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. That means it doesn’t take debt or cash into account. 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.
Is Debt Impacting AB SKF’s P/E?
AB SKF has net debt worth just 6.9% 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 Verdict On AB SKF’s P/E Ratio
AB SKF trades on a P/E ratio of 12.5, which is below the SE market average of 18.4. The debt levels are not a major concern, but the lack of EPS growth is likely weighing on sentiment.
Investors have an opportunity when market expectations about a stock are wrong. 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.
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.
If you spot an error that warrants correction, please contact the editor at email@example.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.