The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll look at Valmet Oyj’s (HEL:VALMT) P/E ratio and reflect on what it tells us about the company’s share price. Based on the last twelve months, Valmet Oyj’s P/E ratio is 19.76. That is equivalent to an earnings yield of about 5.1%.
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How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Valmet Oyj:
P/E of 19.76 = €22.98 ÷ €1.16 (Based on the year to March 2019.)
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 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
Generally speaking the rate of earnings growth has a profound impact on a company’s P/E multiple. When earnings grow, the ‘E’ increases, over time. 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.
In the last year, Valmet Oyj grew EPS like Taylor Swift grew her fan base back in 2010; the 57% gain was both fast and well deserved. Even better, EPS is up 30% per year over three years. So you might say it really deserves to have an above-average P/E ratio.
How Does Valmet Oyj’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. As you can see below Valmet Oyj has a P/E ratio that is fairly close for the average for the machinery industry, which is 19.8.
That indicates that the market expects Valmet Oyj will perform roughly in line with other companies in its industry. The company could surprise by performing better than average, in the future. Further research into factors such asmanagement tenure, could help you form your own view on whether that is likely.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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).
While growth expenditure doesn’t always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
How Does Valmet Oyj’s Debt Impact Its P/E Ratio?
Since Valmet Oyj holds net cash of €152m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Verdict On Valmet Oyj’s P/E Ratio
Valmet Oyj trades on a P/E ratio of 19.8, which is fairly close to the FI market average of 19.8. Its net cash position is the cherry on top of its superb EPS growth. So at a glance we’re a bit surprised that Valmet Oyj does not have a higher P/E ratio. All the more so, since analysts expect further profit growth. Click here to research this potential opportunity..
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 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 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.