Should You Be Tempted To Sell AUDI AG (ETR:NSU) Because Of Its P/E Ratio?

This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll apply a basic P/E ratio analysis to AUDI AG’s (ETR:NSU), to help you decide if the stock is worth further research. What is AUDI’s P/E ratio? Well, based on the last twelve months it is 11.48. That corresponds to an earnings yield of approximately 8.7%.

View our latest analysis for AUDI

How Do You Calculate AUDI’s P/E Ratio?

The formula for price to earnings is:

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

Or for AUDI:

P/E of 11.48 = €806.00 ÷ €70.21 (Based on the year to June 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 isn’t necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.

Does AUDI 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. As you can see below AUDI has a P/E ratio that is fairly close for the average for the auto industry, which is 10.8.

XTRA:NSU Price Estimation Relative to Market, December 23rd 2019
XTRA:NSU Price Estimation Relative to Market, December 23rd 2019

That indicates that the market expects AUDI will perform roughly in line with other companies in its industry. If the company has better than average prospects, then the market might be underestimating it. 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

Companies that shrink earnings per share quickly will rapidly decrease the ‘E’ in the equation. That means unless the share price falls, the P/E will increase in a few years. A higher P/E should indicate the stock is expensive relative to others — and that may encourage shareholders to sell.

AUDI saw earnings per share decrease by 21% last year. And over the longer term (5 years) earnings per share have decreased 6.0% annually. This might lead to muted expectations.

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. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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.

AUDI’s Balance Sheet

With net cash of €17b, AUDI has a very strong balance sheet, which may be important for its business. Having said that, at 49% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.

The Verdict On AUDI’s P/E Ratio

AUDI’s P/E is 11.5 which is below average (21.0) in the DE market. The recent drop in earnings per share would make investors cautious, 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. Although we don’t have analyst forecasts you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.

Of course you might be able to find a better stock than AUDI. 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 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.

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.