Should You Be Tempted To Sell EssilorLuxottica Société anonyme (EPA:EL) Because Of Its P/E Ratio?

Today, we’ll introduce the concept of the P/E ratio for those who are learning about investing. We’ll apply a basic P/E ratio analysis to EssilorLuxottica Société anonyme’s (EPA:EL), to help you decide if the stock is worth further research. Based on the last twelve months, EssilorLuxottica Société anonyme’s P/E ratio is 39.59. That corresponds to an earnings yield of approximately 2.5%.

See our latest analysis for EssilorLuxottica Société anonyme

How Do I Calculate EssilorLuxottica Société anonyme’s Price To Earnings Ratio?

The formula for P/E is:

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

Or for EssilorLuxottica Société anonyme:

P/E of 39.59 = €133 ÷ €3.36 (Based on the trailing twelve months 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. All else being equal, it’s better to pay a low price — but as Warren Buffett said, ‘It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.’

Does EssilorLuxottica Société anonyme 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. The image below shows that EssilorLuxottica Société anonyme has a higher P/E than the average (26.7) P/E for companies in the luxury industry.

ENXTPA:EL Price Estimation Relative to Market, August 29th 2019
ENXTPA:EL Price Estimation Relative to Market, August 29th 2019

That means that the market expects EssilorLuxottica Société anonyme will outperform other companies in its industry.

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. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.

EssilorLuxottica Société anonyme saw earnings per share decrease by 37% last year. And it has shrunk its earnings per share by 6.4% per year over the last five years. This might lead to muted expectations.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. That means it doesn’t take debt or cash into account. 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.

How Does EssilorLuxottica Société anonyme’s Debt Impact Its P/E Ratio?

EssilorLuxottica Société anonyme has net debt worth just 4.8% of its market capitalization. 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 Verdict On EssilorLuxottica Société anonyme’s P/E Ratio

EssilorLuxottica Société anonyme’s P/E is 39.6 which is above average (17.1) in its market. With modest debt but no EPS growth in the last year, it’s fair to say the P/E implies some optimism about future earnings, from the market.

When the market is wrong about a stock, it gives savvy investors an opportunity. 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 report on the analyst consensus forecasts could help you make a master move on this stock.

You might be able to find a better buy than EssilorLuxottica Société anonyme. 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.