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 DPA Group N.V.’s (AMS:DPA) P/E ratio could help you assess the value on offer. DPA Group has a P/E ratio of 8.45, based on the last twelve months. That is equivalent to an earnings yield of about 12%.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for DPA Group:
P/E of 8.45 = €1.5 ÷ €0.18 (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
If earnings fall then in the future the ‘E’ will be lower. That means even if the current P/E is low, it will increase over time if the share price stays flat. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
Notably, DPA Group grew EPS by a whopping 321% in the last year. And it has bolstered its earnings per share by 8.5% per year over the last five years. With that performance, I would expect it to have an above average P/E ratio. In contrast, EPS has decreased by 1.5%, annually, over 3 years.
How Does DPA Group’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that DPA Group has a lower P/E than the average (14.5) P/E for companies in the professional services industry.
DPA Group’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 DPA Group, it’s quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
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 DPA Group’s P/E?
DPA Group has net debt worth 24% of its market capitalization. It would probably deserve a higher P/E ratio if it was net cash, since it would have more options for growth.
The Bottom Line On DPA Group’s P/E Ratio
DPA Group’s P/E is 8.5 which is below average (17) in the NL market. The company does have a little debt, and EPS growth was good last year. If it continues to grow, then the current low P/E may prove to be unjustified.
When the market is wrong about a stock, it gives savvy investors an opportunity. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
But note: DPA Group may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.