Read This Before You Buy Koninklijke DSM N.V. (AMS:DSM) Because Of Its P/E Ratio

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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 Koninklijke DSM N.V.’s (AMS:DSM) P/E ratio could help you assess the value on offer. Koninklijke DSM has a P/E ratio of 14.87, based on the last twelve months. In other words, at today’s prices, investors are paying €14.87 for every €1 in prior year profit.

Check out our latest analysis for Koninklijke DSM

How Do I Calculate Koninklijke DSM’s Price To Earnings Ratio?

The formula for P/E is:

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

Or for Koninklijke DSM:

P/E of 14.87 = €90.68 ÷ €6.1 (Based on the year to December 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. 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

P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the ‘E’ will be higher. That means even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.

Koninklijke DSM shrunk earnings per share by 39% over the last year. But over the longer term (5 years) earnings per share have increased by 52%.

How Does Koninklijke DSM’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 Koninklijke DSM has a lower P/E than the average (18.2) P/E for companies in the chemicals industry.

ENXTAM:DSM Price Estimation Relative to Market, February 22nd 2019
ENXTAM:DSM Price Estimation Relative to Market, February 22nd 2019

Koninklijke DSM’s P/E tells us that market participants think it will not fare as well as its peers in the same industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. You should delve deeper. I like to check if company insiders have been buying or selling.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

The ‘Price’ in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Theoretically, a business can improve its earnings (and produce a lower P/E in the future), by taking on debt (or spending its remaining 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).

Koninklijke DSM’s Balance Sheet

Koninklijke DSM’s net debt is 0.6% of its market cap. The market might award it a higher P/E ratio if it had net cash, but its unlikely this low level of net borrowing is having a big impact on the P/E multiple.

The Verdict On Koninklijke DSM’s P/E Ratio

Koninklijke DSM’s P/E is 14.9 which is below average (16.1) in the NL market. The debt levels are not a major concern, but the lack of EPS growth is likely weighing on sentiment.

When the market is wrong about a stock, it gives savvy investors an opportunity. 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 free visual report on analyst forecasts could hold the key to an excellent investment decision.

You might be able to find a better buy than Koninklijke DSM. 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.