Is HELLA GmbH & Co. KGaA's (ETR:HLE) High P/E Ratio A Problem For Investors?

Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at HELLA GmbH & Co. KGaA's (ETR:HLE) P/E ratio and reflect on what it tells us about the company's share price. What is HELLA GmbH KGaA's P/E ratio? Well, based on the last twelve months it is 13.93. That is equivalent to an earnings yield of about 7.2%.

Check out our latest analysis for HELLA GmbH KGaA

How Do You Calculate A P/E Ratio?

The formula for price to earnings is:

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

Or for HELLA GmbH KGaA:

P/E of 13.93 = EUR43.64 ÷ EUR3.13 (Based on the trailing twelve months to November 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each EUR1 of company 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 HELLA GmbH KGaA Have A Relatively High Or Low P/E For Its Industry?

We can get an indication of market expectations by looking at the P/E ratio. You can see in the image below that the average P/E (13.9) for companies in the auto components industry is roughly the same as HELLA GmbH KGaA's P/E.

Its P/E ratio suggests that HELLA GmbH KGaA shareholders think that in the future it will perform about the same as other companies in its industry classification. So if HELLA GmbH KGaA actually outperforms its peers going forward, that should be a positive for the share price. Further research into factors such as insider buying and selling, could help you form your own view on whether that is likely.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. When earnings grow, the 'E' increases, over time. That means even if the current P/E is high, it will reduce over time if the share price stays flat. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

HELLA GmbH KGaA saw earnings per share decrease by 45% last year. But over the longer term (5 years) earnings per share have increased by 3.6%.

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

The 'Price' in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).

Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.

HELLA GmbH KGaA's Balance Sheet

HELLA GmbH KGaA's net debt is 1.1% of its market cap. So it doesn't have as many options as it would with net cash, but its debt would not have much of an impact on its P/E ratio.

The Bottom Line On HELLA GmbH KGaA's P/E Ratio

HELLA GmbH KGaA's P/E is 13.9 which is below average (20.9) in the DE market. With only modest debt, it's likely the lack of EPS growth at least partially explains the pessimism implied by the P/E ratio.

When the market is wrong about a stock, it gives savvy investors an opportunity. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

But note: HELLA GmbH KGaA 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).

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.