The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we’ll show how Fernheizwerk Neukölln Aktiengesellschaft’s (FRA:FHW) P/E ratio could help you assess the value on offer. Fernheizwerk Neukölln has a P/E ratio of 16.94, based on the last twelve months. In other words, at today’s prices, investors are paying €16.94 for every €1 in prior year profit.
View our latest analysis for Fernheizwerk Neukölln
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Fernheizwerk Neukölln:
P/E of 16.94 = €45.60 ÷ €2.69 (Based on the year to December 2018.)
Is A High Price-to-Earnings 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 is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
Does Fernheizwerk Neukölln 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. As you can see below, Fernheizwerk Neukölln has a higher P/E than the average company (15.5) in the water utilities industry.
Its relatively high P/E ratio indicates that Fernheizwerk Neukölln shareholders think it will perform better than other companies in its industry classification.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. 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.
Fernheizwerk Neukölln’s earnings per share fell by 15% in the last twelve months. But EPS is up 6.0% over the last 5 years. The market might expect further 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
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. So it won’t reflect the advantage of cash, or disadvantage of debt. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
Fernheizwerk Neukölln’s Balance Sheet
With net cash of €16m, Fernheizwerk Neukölln has a very strong balance sheet, which may be important for its business. Having said that, at 15% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Verdict On Fernheizwerk Neukölln’s P/E Ratio
Fernheizwerk Neukölln trades on a P/E ratio of 16.9, which is below the DE market average of 20.2. Falling earnings per share are likely to be keeping potential buyers away, 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.
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. Although we don’t have analyst forecasts shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
But note: Fernheizwerk Neukölln 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).
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 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. Thank you for reading.