The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll look at AB Electrolux (publ)’s (STO:ELUX B) P/E ratio and reflect on what it tells us about the company’s share price. Looking at earnings over the last twelve months, AB Electrolux has a P/E ratio of 35.18. That corresponds to an earnings yield of approximately 2.8%.
How Do I Calculate AB Electrolux’s Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for AB Electrolux:
P/E of 35.18 = SEK222.90 ÷ SEK6.34 (Based on the trailing twelve months to December 2019.)
Is A High P/E Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. 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 Does AB Electrolux’s P/E Ratio Compare To Its Peers?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. As you can see below, AB Electrolux has a higher P/E than the average company (15.6) in the consumer durables industry.
AB Electrolux’s P/E tells us that market participants think the company will perform better than its industry peers, going forward. Clearly the market expects growth, but it isn’t guaranteed. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
How Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the ‘E’ in the equation. That means even if the current P/E is low, it will increase over time if the share price stays flat. A higher P/E should indicate the stock is expensive relative to others — and that may encourage shareholders to sell.
AB Electrolux saw earnings per share decrease by 52% last year. And over the longer term (5 years) earnings per share have decreased 4.1% annually. This might lead to muted expectations.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. So it won’t reflect the advantage of cash, or disadvantage of debt. 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).
While growth expenditure doesn’t always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
So What Does AB Electrolux’s Balance Sheet Tell Us?
AB Electrolux has net debt worth just 1.3% of its market capitalization. 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 Bottom Line On AB Electrolux’s P/E Ratio
AB Electrolux has a P/E of 35.2. That’s higher than the average in its market, which is 19.8. With a bit of debt, but a lack of recent growth, it’s safe to say the market is expecting improved profit performance from the company, in the next few years.
Investors have an opportunity when market expectations about a stock are wrong. 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 visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
You might be able to find a better buy than AB Electrolux. 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).
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.
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