This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we’ll show how Geke S.A.’s (ATH:PRESD) P/E ratio could help you assess the value on offer. Geke has a price to earnings ratio of 16.31, based on the last twelve months. That corresponds to an earnings yield of approximately 6.1%.
Want to help shape the future of investing tools and platforms? Take the survey and be part of one of the most advanced studies of stock market investors to date.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Geke:
P/E of 16.31 = €4.96 ÷ €0.30 (Based on the year to June 2018.)
Is A High P/E Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each €1 of company earnings. That isn’t necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. Earnings growth means that in the future the ‘E’ will be higher. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
It’s great to see that Geke grew EPS by 10% in the last year. And earnings per share have improved by 40% annually, over the last five years. So one might expect an above average P/E ratio.
How Does Geke’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. If you look at the image below, you can see Geke has a lower P/E than the average (18.1) in the hospitality industry classification.
Geke’s P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Geke, 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.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don’t forget that the P/E ratio considers market capitalization. That means it doesn’t take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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.
Is Debt Impacting Geke’s P/E?
Since Geke holds net cash of €5.9m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Verdict On Geke’s P/E Ratio
Geke’s P/E is 16.3 which is above average (12.6) in the GR market. With cash in the bank the company has plenty of growth options — and it is already on the right track. So it does not seem strange that the P/E is above average.
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. 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 be able to find a better stock than Geke. So you may wish to see this free collection of other companies that have grown earnings strongly.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.