Should We Worry About Valeo SA's (EPA:FR) P/E Ratio?

This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll look at Valeo SA's (EPA:FR) P/E ratio and reflect on what it tells us about the company's share price. Valeo has a price to earnings ratio of 31.43, based on the last twelve months. That is equivalent to an earnings yield of about 3.2%.

Check out our latest analysis for Valeo

How Do I Calculate A Price To Earnings Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)

Or for Valeo:

P/E of 31.43 = €33.71 ÷ €1.07 (Based on the year to June 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 Does Valeo's P/E Ratio Compare To Its Peers?

One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. The image below shows that Valeo has a significantly higher P/E than the average (8.5) P/E for companies in the auto components industry.

That means that the market expects Valeo will outperform other companies in its industry.

How Growth Rates Impact P/E Ratios

If earnings fall then in the future the 'E' will be lower. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. Then, a higher P/E might scare off shareholders, pushing the share price down.

Valeo saw earnings per share decrease by 69% last year. And it has shrunk its earnings per share by 13% per year over the last five years. This growth rate might warrant a below average P/E ratio. If the company can grow EPS strongly, the market may improve its opinion of it. Further research into factors such as insider buying and selling, 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. So it won't reflect the advantage of cash, or disadvantage of debt. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

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).

Is Debt Impacting Valeo's P/E?

Net debt is 34% of Valeo's market cap. While that's enough to warrant consideration, it doesn't really concern us.

The Bottom Line On Valeo's P/E Ratio

Valeo has a P/E of 31.4. That's higher than the average in its market, which is 17.3. With a bit of debt, but a lack of recent growth, it's safe to say the market is expecting improved profit performance from the company, in the next few years.

When the market is wrong about a stock, it gives savvy investors an opportunity. 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.

You might be able to find a better buy than Valeo. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

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.