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 Palfinger AG’s (VIE:PAL) P/E ratio could help you assess the value on offer. Palfinger has a P/E ratio of 19.77, based on the last twelve months. In other words, at today’s prices, investors are paying €19.77 for every €1 in prior year profit.
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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 Palfinger:
P/E of 19.77 = €26.45 ÷ €1.34 (Based on the year to September 2018.)
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 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.
How Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the ‘E’ in the equation. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. Then, a higher P/E might scare off shareholders, pushing the share price down.
Palfinger saw earnings per share decrease by 19% last year. But EPS is up 4.8% over the last 5 years. And it has shrunk its earnings per share by 8.8% per year over the last three years. This growth rate might warrant a low P/E ratio. This might lead to low expectations.
How Does Palfinger’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that Palfinger has a higher P/E than the average (15.9) P/E for companies in the machinery industry.
That means that the market expects Palfinger will outperform other companies in its industry. Clearly the market expects growth, but it isn’t guaranteed. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
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. Theoretically, a business can improve its earnings (and produce a lower P/E in the future), by taking on debt (or spending its remaining cash).
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).
How Does Palfinger’s Debt Impact Its P/E Ratio?
Palfinger has net debt worth 56% of its market capitalization. If you want to compare its P/E ratio to other companies, you should absolutely keep in mind it has significant borrowings.
The Verdict On Palfinger’s P/E Ratio
Palfinger’s P/E is 19.8 which is above average (14) in the AT market. With meaningful debt and a lack of recent earnings growth, the market has high expectations that the business will earn more in the future.
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.’ 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.
But note: Palfinger may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.