This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll apply a basic P/E ratio analysis to Aker Solutions ASA’s (OB:AKSO), to help you decide if the stock is worth further research. Looking at earnings over the last twelve months, Aker Solutions has a P/E ratio of 17.01. That means that at current prices, buyers pay NOK17.01 for every NOK1 in trailing yearly profits.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Aker Solutions:
P/E of 17.01 = NOK25.81 ÷ NOK1.52 (Based on the year to June 2019.)
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 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 Does Aker Solutions’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that Aker Solutions has a P/E ratio that is roughly in line with the energy services industry average (15.9).
Aker Solutions’s P/E tells us that market participants think its prospects are roughly in line with its industry.
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. When earnings grow, the ‘E’ increases, over time. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.
Most would be impressed by Aker Solutions earnings growth of 17% in the last year. And it has improved its earnings per share by 23% per year over the last three years. This could arguably justify a relatively high P/E ratio. But earnings per share are down 20% per year over the last five years.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. That means it doesn’t take debt or cash into account. 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 Aker Solutions’s Debt Impact Its P/E Ratio?
Net debt totals 19% of Aker Solutions’s market cap. 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 Aker Solutions’s P/E Ratio
Aker Solutions has a P/E of 17. That’s higher than the average in its market, which is 12.5. The company is not overly constrained by its modest debt levels, and its recent EPS growth very solid. Therefore, it’s not particularly surprising that it has a above average P/E ratio.
When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. 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 Aker Solutions. 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 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.