Is Linedata Services S.A.'s (EPA:LIN) P/E Ratio Really That Good?

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Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll show how you can use Linedata Services S.A.'s (EPA:LIN) P/E ratio to inform your assessment of the investment opportunity. Linedata Services has a P/E ratio of 9.44, based on the last twelve months. That means that at current prices, buyers pay €9.44 for every €1 in trailing yearly profits.

See our latest analysis for Linedata Services

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 Linedata Services:

P/E of 9.44 = €26.9 ÷ €2.85 (Based on the year to December 2018.)

Is A High P/E 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. 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

Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. That means even if the current P/E is low, it will increase over time if the share price stays flat. Then, a higher P/E might scare off shareholders, pushing the share price down.

Linedata Services's earnings per share grew by -3.7% in the last twelve months. And earnings per share have improved by 3.9% annually, over the last five years. Unfortunately, earnings per share are down 6.6% a year, over 3 years.

Does Linedata Services 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. If you look at the image below, you can see Linedata Services has a lower P/E than the average (24.9) in the software industry classification.

This suggests that market participants think Linedata Services will underperform other companies in its industry. Since the market seems unimpressed with Linedata Services, it's quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.

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. 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).

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).

How Does Linedata Services's Debt Impact Its P/E Ratio?

Linedata Services's net debt equates to 44% of its market capitalization. While that's enough to warrant consideration, it doesn't really concern us.

The Verdict On Linedata Services's P/E Ratio

Linedata Services has a P/E of 9.4. That's below the average in the FR market, which is 17.7. EPS grew over the last twelve months, and debt levels are quite reasonable. If growth is sustainable over the long term, then the current P/E ratio may be a sign of good value.

Investors have an opportunity when market expectations about a stock are wrong. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. 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 Linedata Services. 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.