Why KLON Spólka Akcyjna's (WSE:KLN) High P/E Ratio Isn't Necessarily A Bad Thing

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 KLON Spólka Akcyjna's (WSE:KLN) P/E ratio could help you assess the value on offer. KLON Spólka Akcyjna has a price to earnings ratio of 25.8, based on the last twelve months. That means that at current prices, buyers pay PLN25.8 for every PLN1 in trailing yearly profits.

Check out our latest analysis for KLON Spólka Akcyjna

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 KLON Spólka Akcyjna:

P/E of 25.8 = PLN1 ÷ PLN0.039 (Based on the trailing twelve months to September 2018.)

Is A High Price-to-Earnings Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing 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

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.

It's great to see that KLON Spólka Akcyjna grew EPS by 12% in the last year. And it has bolstered its earnings per share by 8.6% per year over the last five years. This could arguably justify a relatively high P/E ratio. Unfortunately, earnings per share are down 11% a year, over 3 years.

How Does KLON Spólka Akcyjna's P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. You can see in the image below that the average P/E (20.7) for companies in the forestry industry is lower than KLON Spólka Akcyjna's P/E.

KLON Spólka Akcyjna's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Shareholders are clearly optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

Remember: P/E Ratios Don't Consider The Balance Sheet

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. So it won't reflect the advantage of cash, or disadvantage of debt. 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.

How Does KLON Spólka Akcyjna's Debt Impact Its P/E Ratio?

Net debt totals 56% of KLON Spólka Akcyjna's market cap. This is enough debt that you'd have to make some adjustments before using the P/E ratio to compare it to a company with net cash.

The Verdict On KLON Spólka Akcyjna's P/E Ratio

KLON Spólka Akcyjna's P/E is 25.8 which is above average (11.2) in the PL market. It has already proven it can grow earnings, but the debt levels mean it faces some risks. But if growth falters, the relatively high P/E ratio may prove to be unjustified.

Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. Although we don't have analyst forecasts, you might want to assess this data-rich visualization of earnings, revenue and cash flow.

Of course you might be able to find a better stock than KLON Spólka Akcyjna. So you may wish to see this freecollection of other companies that have grown earnings strongly.

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.