This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll look at Deutsche Telekom AG’s (FRA:DTE) P/E ratio and reflect on what it tells us about the company’s share price. Deutsche Telekom has a price to earnings ratio of 34.62, based on the last twelve months. In other words, at today’s prices, investors are paying €34.62 for every €1 in prior year profit.
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How Do You Calculate Deutsche Telekom’s P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Deutsche Telekom:
P/E of 34.62 = €15.14 ÷ €0.44 (Based on the trailing twelve months to March 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. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
How Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the ‘E’ in the equation. That means unless the share price falls, the P/E will increase in a few years. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
Deutsche Telekom shrunk earnings per share by 44% over the last year. And EPS is down 2.5% a year, over the last 5 years. This could justify a pessimistic P/E.
Does Deutsche Telekom 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. If you look at the image below, you can see Deutsche Telekom has a lower P/E than the average (41.6) in the telecom industry classification.
This suggests that market participants think Deutsche Telekom will underperform other companies in its industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. 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
The ‘Price’ in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. 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.
Deutsche Telekom’s Balance Sheet
Net debt totals a substantial 106% of Deutsche Telekom’s market cap. If you want to compare its P/E ratio to other companies, you must keep in mind that these debt levels would usually warrant a relatively low P/E.
The Verdict On Deutsche Telekom’s P/E Ratio
Deutsche Telekom has a P/E of 34.6. That’s higher than the average in the DE market, which is 20.2. With significant debt and no EPS growth last year, shareholders are betting on an improvement in earnings from the company.
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.
Of course you might be able to find a better stock than Deutsche Telekom. 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.