The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we’ll show how Softing AG’s (ETR:SYT) P/E ratio could help you assess the value on offer. Based on the last twelve months, Softing’s P/E ratio is 14.40. In other words, at today’s prices, investors are paying €14.40 for every €1 in prior year profit.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Softing:
P/E of 14.40 = €5.720 ÷ €0.397 (Based on the trailing twelve months to September 2019.)
(Note: the above calculation results may not be precise due to rounding.)
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 Softing’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. If you look at the image below, you can see Softing has a lower P/E than the average (20.6) in the electronic industry classification.
Its relatively low P/E ratio indicates that Softing shareholders think it will struggle to do as well as other companies in its industry classification. 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
If earnings fall then in the future the ‘E’ will be lower. That means unless the share price falls, the P/E will increase in a few years. Then, a higher P/E might scare off shareholders, pushing the share price down.
It’s nice to see that Softing grew EPS by a stonking 36% in the last year. Unfortunately, earnings per share are down 10% a year, over 5 years.
Remember: P/E Ratios Don’t Consider The Balance Sheet
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. 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.
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.
Is Debt Impacting Softing’s P/E?
The extra options and safety that comes with Softing’s €505k net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Verdict On Softing’s P/E Ratio
Softing’s P/E is 14.4 which is below average (18.4) in the DE market. It grew its EPS nicely over the last year, and the healthy balance sheet implies there is more potential for growth. The below average P/E ratio suggests that market participants don’t believe the strong growth will continue.
Investors have an opportunity when market expectations about a stock are wrong. 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.
Of course you might be able to find a better stock than Softing. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.
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