Today, we’ll introduce the concept of the P/E ratio for those who are learning about investing. We’ll show how you can use Zenitel NV’s (EBR:ZENT) P/E ratio to inform your assessment of the investment opportunity. Zenitel has a price to earnings ratio of 19.59, based on the last twelve months. That is equivalent to an earnings yield of about 5.1%.
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Zenitel:
P/E of 19.59 = €15.7 ÷ €0.80 (Based on the year to December 2018.)
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. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
Does Zenitel Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. If you look at the image below, you can see Zenitel has a lower P/E than the average (22.6) in the communications industry classification.
Its relatively low P/E ratio indicates that Zenitel shareholders think it will struggle to do as well as other companies in its industry classification.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. If earnings are growing quickly, then the ‘E’ in the equation will increase faster than it would otherwise. That means unless the share price increases, the P/E will reduce in a few years. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
It’s great to see that Zenitel grew EPS by 17% in the last year. And earnings per share have improved by 6.4% annually, over the last three years. With that performance, you might expect an above average P/E ratio. In contrast, EPS has decreased by 5.6%, annually, over 5 years.
Remember: P/E Ratios Don’t Consider The Balance Sheet
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. In other words, it does not consider any debt or cash that the company may have on the balance sheet. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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.
Is Debt Impacting Zenitel’s P/E?
With net cash of €18m, Zenitel has a very strong balance sheet, which may be important for its business. Having said that, at 35% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Verdict On Zenitel’s P/E Ratio
Zenitel’s P/E is 19.6 which is above average (15.1) in its market. Its net cash position supports a higher P/E ratio, as does its solid recent earnings growth. So it does not seem strange that the P/E is above average.
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. We don’t have analyst forecasts, but shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
Of course you might be able to find a better stock than Zenitel. So you may wish to see this free collection of other companies that have grown earnings strongly.
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 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. Thank you for reading.