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 Soprano Oyj’s (HEL:SOPRA) P/E ratio to inform your assessment of the investment opportunity. What is Soprano Oyj’s P/E ratio? Well, based on the last twelve months it is 28.91. That corresponds to an earnings yield of approximately 3.5%.
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How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Soprano Oyj:
P/E of 28.91 = €0.29 ÷ €0.010 (Based on the trailing twelve months to December 2018.)
Is A High P/E Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. All else being equal, it’s better to pay a low price — but as Warren Buffett said, ‘It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.’
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. Earnings growth means that in the future the ‘E’ will be higher. And in that case, the P/E ratio itself will drop rather quickly. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Soprano Oyj saw earnings per share decrease by 56% last year. And EPS is down 22% a year, over the last 5 years. This growth rate might warrant a below average P/E ratio.
Does Soprano Oyj Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. The image below shows that Soprano Oyj has a P/E ratio that is roughly in line with the professional services industry average (27.1).
Its P/E ratio suggests that Soprano Oyj shareholders think that in the future it will perform about the same as other companies in its industry classification. If the company has better than average prospects, then the market might be underestimating it. Checking factors such as the tenure of the board and management could help you form your own view on if that will happen.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don’t forget that the P/E ratio considers market capitalization. So it won’t reflect the advantage of cash, or disadvantage of debt. 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).
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).
Soprano Oyj’s Balance Sheet
Soprano Oyj’s net debt is 52% of its market cap. This is enough debt that you’d have to make some adjustments before using the P/E ratio to compare it to a company with net cash.
The Verdict On Soprano Oyj’s P/E Ratio
Soprano Oyj’s P/E is 28.9 which is above average (19.8) in the FI market. With significant debt and no EPS growth last year, shareholders are betting on an improvement in earnings from the company.
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. We don’t have analyst forecasts, but shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
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.