The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll look at Telecom Italia SpA's (BIT:TIT) P/E ratio and reflect on what it tells us about the company's share price. Telecom Italia has a price to earnings ratio of 9.86, based on the last twelve months. That means that at current prices, buyers pay €9.86 for every €1 in trailing yearly profits.
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Telecom Italia:
P/E of 9.86 = €0.51 ÷ €0.051 (Based on the trailing twelve months to June 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. 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
Probably the most important factor in determining what P/E a company trades on is the earnings growth. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. That means even if the current P/E is high, it will reduce over time if the share price stays flat. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Telecom Italia saw earnings per share decrease by 22% last year. But EPS is up 65% over the last 5 years.
How Does Telecom Italia's P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. We can see in the image below that the average P/E (21.6) for companies in the telecom industry is higher than Telecom Italia's P/E.
BIT:TIT PE PEG Gauge October 31st 18
This suggests that market participants think Telecom Italia will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. 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. 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.
Is Debt Impacting Telecom Italia's P/E?
Net debt totals a substantial 269% of Telecom Italia's market cap. If you want to compare its P/E ratio to other companies, you must keep in mind that these debt levels would usually warrant a relatively low P/E.
The Verdict On Telecom Italia's P/E Ratio
Telecom Italia's P/E is 9.9 which is below average (15.2) in the IT market. When you consider that the company has significant debt, and didn't grow EPS last year, it isn't surprising that the market has muted expectations.
Investors have an opportunity when market expectations about a stock are wrong. 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 freevisual report on analyst forecasts could hold they key to an excellent investment decision.
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 editorial-team@simplywallst.com.
Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
About BIT:TIT
Telecom Italia
Engages in the fixed and mobile telecommunications services in Italy and internationally.
