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 Stalprodukt S.A.’s (WSE:STP) P/E ratio could help you assess the value on offer. Stalprodukt has a price to earnings ratio of 6.66, based on the last twelve months. In other words, at today’s prices, investors are paying PLN6.66 for every PLN1 in prior year profit.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Stalprodukt:
P/E of 6.66 = PLN328 ÷ PLN49.26 (Based on the trailing twelve months 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
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 unless the share price increases, the P/E will reduce in a few years. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Stalprodukt’s earnings per share grew by -8.0% in the last twelve months. And earnings per share have improved by 27% annually, over the last five years.
How Does Stalprodukt’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. As you can see below Stalprodukt has a P/E ratio that is fairly close for the average for the metals and mining industry, which is 6.8.
That indicates that the market expects Stalprodukt will perform roughly in line with other companies in its industry. So if Stalprodukt actually outperforms its peers going forward, that should be a positive for the share price. I inform my view byby checking management tenure and remuneration, among other things.
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. 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).
How Does Stalprodukt’s Debt Impact Its P/E Ratio?
Since Stalprodukt holds net cash of zł235m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Verdict On Stalprodukt’s P/E Ratio
Stalprodukt’s P/E is 6.7 which is below average (10.9) in the PL market. Recent earnings growth wasn’t bad. And the healthy balance sheet means the company can sustain growth while the P/E suggests shareholders don’t think it will.
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 visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
But note: Stalprodukt 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).
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 email@example.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.