This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we’ll show how Asaleo Care Limited’s (ASX:AHY) P/E ratio could help you assess the value on offer. Asaleo Care has a price to earnings ratio of 25.71, based on the last twelve months. That means that at current prices, buyers pay A$25.71 for every A$1 in trailing yearly profits.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Asaleo Care:
P/E of 25.71 = AUD1.09 ÷ AUD0.04 (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 AUD1 the company has earned over the last year. That isn’t a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business’s prospects, relative to stocks with a lower P/E.
Does Asaleo Care Have A Relatively High Or Low P/E For Its Industry?
We can get an indication of market expectations by looking at the P/E ratio. You can see in the image below that the average P/E (25.7) for companies in the personal products industry is roughly the same as Asaleo Care’s P/E.
Its P/E ratio suggests that Asaleo Care shareholders think that in the future it will perform about the same as other companies in its industry classification. So if Asaleo Care actually outperforms its peers going forward, that should be a positive for the share price. Checking factors such as director buying and selling. could help you form your own view on if that will happen.
How Growth Rates Impact P/E Ratios
When earnings fall, the ‘E’ decreases, over time. That means even if the current P/E is low, it will increase over time if the share price stays flat. Then, a higher P/E might scare off shareholders, pushing the share price down.
Asaleo Care increased earnings per share by a whopping 38% last year. Unfortunately, earnings per share are down 29% a year, over 3 years.
Remember: P/E Ratios Don’t Consider The Balance Sheet
Don’t forget that the P/E ratio considers market capitalization. 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 spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
So What Does Asaleo Care’s Balance Sheet Tell Us?
Asaleo Care’s net debt equates to 25% of its market capitalization. While that’s enough to warrant consideration, it doesn’t really concern us.
The Bottom Line On Asaleo Care’s P/E Ratio
Asaleo Care has a P/E of 25.7. That’s higher than the average in its market, which is 18.8. While the company does use modest debt, its recent earnings growth is superb. So on this analysis a high P/E ratio seems reasonable.
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. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
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.
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