The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll apply a basic P/E ratio analysis to Alm. Brand A/S’s (CPH:ALMB), to help you decide if the stock is worth further research. Looking at earnings over the last twelve months, Alm. Brand has a P/E ratio of 18.01. In other words, at today’s prices, investors are paying DKK18.01 for every DKK1 in prior year profit.
How Do You Calculate Alm. Brand’s P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Alm. Brand:
P/E of 18.01 = DKK64.8 ÷ DKK3.6 (Based on the year to December 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each DKK1 of company earnings. That isn’t necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. If earnings are growing quickly, then the ‘E’ in the equation will increase faster than it would otherwise. And in that case, the P/E ratio itself will drop rather quickly. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
Alm. Brand saw earnings per share decrease by 28% last year. But it has grown its earnings per share by 29% per year over the last five years.
How Does Alm. Brand’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. As you can see below, Alm. Brand has a higher P/E than the average company (13.9) in the insurance industry.
Its relatively high P/E ratio indicates that Alm. Brand shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
The ‘Price’ in P/E reflects the market capitalization of the company. That means it doesn’t take debt or cash into account. 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 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.
Alm. Brand’s Balance Sheet
Since Alm. Brand holds net cash of ø87m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Bottom Line On Alm. Brand’s P/E Ratio
Alm. Brand has a P/E of 18. That’s around the same as the average in the DK market, which is 17.8. While the absence of growth in the last year is probably causing a degree of pessimism, the relatively strong balance sheet will allow the company to weather a storm; so it isn’t very surprising to see that it has a P/E ratio close to the market average.
Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E 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 firstname.lastname@example.org. 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.