The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll show how you can use Koenig & Bauer AG’s (FRA:SKB) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Koenig & Bauer’s P/E ratio is 9.42. That is equivalent to an earnings yield of about 11%.
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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 Koenig & Bauer:
P/E of 9.42 = €40.94 ÷ €4.35 (Based on the trailing twelve months to September 2018.)
Is A High P/E Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each €1 the company has earned over the last year. 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
Earnings growth rates have a big influence on P/E ratios. When earnings grow, the ‘E’ increases, over time. That means unless the share price increases, the P/E will reduce in a few years. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Koenig & Bauer saw earnings per share decrease by 9.3% last year. But over the longer term (5 years) earnings per share have increased by 67%.
How Does Koenig & Bauer’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. The image below shows that Koenig & Bauer has a lower P/E than the average (14.6) P/E for companies in the machinery industry.
Koenig & Bauer’s P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Koenig & Bauer, it’s quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
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. 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).
Is Debt Impacting Koenig & Bauer’s P/E?
Koenig & Bauer has net cash of €90m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Verdict On Koenig & Bauer’s P/E Ratio
Koenig & Bauer has a P/E of 9.4. That’s below the average in the DE market, which is 17.6. The recent drop in earnings per share would almost certainly temper expectations, the relatively strong balance sheet will allow the company time to invest in growth. If it achieves that, then there’s real potential that the low P/E could eventually indicate undervaluation.
Investors have an opportunity when market expectations about a stock are wrong. 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.
You might be able to find a better buy than Koenig & Bauer. 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).
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.