Does Nokian Renkaat Oyj's (HEL:TYRES) P/E Ratio Signal A Buying Opportunity?

This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll look at Nokian Renkaat Oyj's (HEL:TYRES) P/E ratio and reflect on what it tells us about the company's share price. Nokian Renkaat Oyj has a P/E ratio of 8.01, based on the last twelve months. That is equivalent to an earnings yield of about 12.5%.

See our latest analysis for Nokian Renkaat Oyj

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 Nokian Renkaat Oyj:

P/E of 8.01 = €25.00 ÷ €3.12 (Based on the trailing twelve months to June 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 is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.

Does Nokian Renkaat Oyj Have A Relatively High Or Low P/E For Its Industry?

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 Nokian Renkaat Oyj has a lower P/E than the average (10.4) in the auto components industry classification.

This suggests that market participants think Nokian Renkaat Oyj will underperform other companies in its industry.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. Earnings growth means that in the future the 'E' will be higher. 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.

Nokian Renkaat Oyj's 79% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. The cherry on top is that the five year growth rate was an impressive 24% per year. With that kind of growth rate we would generally expect a high P/E ratio. The market might expect further growth, but it isn't guaranteed. 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

Don't forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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.

Nokian Renkaat Oyj's Balance Sheet

Nokian Renkaat Oyj's net debt is 3.6% of its market cap. It would probably trade on a higher P/E ratio if it had a lot of cash, but I doubt it is having a big impact.

The Bottom Line On Nokian Renkaat Oyj's P/E Ratio

Nokian Renkaat Oyj has a P/E of 8.0. That's below the average in the FI market, which is 20.2. The company does have a little debt, and EPS growth was good last year. If it continues to grow, then the current low P/E may prove to be unjustified.

When the market is wrong about a stock, it gives savvy investors an opportunity. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. 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 Nokian Renkaat Oyj. 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.