Today, we’ll introduce the concept of the P/E ratio for those who are learning about investing. We’ll look at Resilux NV’s (EBR:RES) P/E ratio and reflect on what it tells us about the company’s share price. Resilux has a P/E ratio of 17.51, based on the last twelve months. That corresponds to an earnings yield of approximately 5.7%.
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Resilux:
P/E of 17.51 = EUR141.50 ÷ EUR8.08 (Based on the year to June 2019.)
Is A High Price-to-Earnings Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. 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 Resilux 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. The image below shows that Resilux has a higher P/E than the average (16.0) P/E for companies in the packaging industry.
Resilux’s P/E tells us that market participants think the company will perform better than its industry peers, going forward. Clearly the market expects growth, but it isn’t guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.
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.
Resilux saw earnings per share decrease by 8.7% last year. But over the longer term (5 years) earnings per share have increased by 10%. And EPS is down 33% a year, over the last 3 years. So it would be surprising to see a high P/E.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. So it won’t reflect the advantage of cash, or disadvantage of debt. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
Resilux’s Balance Sheet
Net debt is 26% of Resilux’s market cap. While it’s worth keeping this in mind, it isn’t a worry.
The Bottom Line On Resilux’s P/E Ratio
Resilux has a P/E of 17.5. That’s around the same as the average in the BE market, which is 17.3. Given it has some debt, but didn’t grow last year, the P/E indicates the market is expecting higher profits ahead for the business.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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 visual report on analyst forecasts could hold the key to an excellent investment decision.
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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