Despite Its High P/E Ratio, Is Elis SA (EPA:ELIS) Still Undervalued?

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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). To keep it practical, we’ll show how Elis SA’s (EPA:ELIS) P/E ratio could help you assess the value on offer. Looking at earnings over the last twelve months, Elis has a P/E ratio of 39.85. That corresponds to an earnings yield of approximately 2.5%.

See our latest analysis for Elis

How Do I Calculate A Price To Earnings Ratio?

The formula for P/E is:

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

Or for Elis:

P/E of 39.85 = €15.15 ÷ €0.38 (Based on the year to December 2018.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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 Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the ‘E’ increases, over time. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.

It’s nice to see that Elis grew EPS by a stonking 45% in the last year.

Does Elis Have A Relatively High Or Low P/E For Its Industry?

One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. As you can see below, Elis has a higher P/E than the average company (17.8) in the commercial services industry.

ENXTPA:ELIS Price Estimation Relative to Market, June 5th 2019
ENXTPA:ELIS Price Estimation Relative to Market, June 5th 2019

Its relatively high P/E ratio indicates that Elis shareholders think it will perform better than other companies in its industry classification. The market is optimistic about the future, but that doesn’t guarantee future growth. So investors should delve deeper. I like to check if company insiders have been buying or selling.

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. That means it doesn’t take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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.

How Does Elis’s Debt Impact Its P/E Ratio?

Elis’s net debt is considerable, at 101% of its market cap. This is a relatively high level of debt, so the stock probably deserves a relatively low P/E ratio. Keep that in mind when comparing it to other companies.

The Verdict On Elis’s P/E Ratio

Elis has a P/E of 39.9. That’s higher than the average in the FR market, which is 17. While its debt levels are rather high, at least its EPS is growing quickly. So it seems likely the market is overlooking the debt because of the fast earnings growth.

When the market is wrong about a stock, it gives savvy investors an opportunity. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

Of course you might be able to find a better stock than Elis. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.