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Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at Ascom Holding AG's (VTX:ASCN) P/E ratio and reflect on what it tells us about the company's share price. Based on the last twelve months, Ascom Holding's P/E ratio is 21.51. In other words, at today's prices, investors are paying CHF21.51 for every CHF1 in prior year profit.

See our latest analysis for Ascom Holding

How Do You Calculate A P/E Ratio?

The formula for P/E is:

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

Or for Ascom Holding:

P/E of 21.51 = CHF12.8 ÷ CHF0.60 (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 isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.

How Does Ascom Holding's P/E Ratio Compare To Its Peers?

The P/E ratio indicates whether the market has higher or lower expectations of a company. You can see in the image below that the average P/E (22) for companies in the healthcare services industry is roughly the same as Ascom Holding's P/E.

Its P/E ratio suggests that Ascom Holding shareholders think that in the future it will perform about the same as other companies in its industry classification. So if Ascom Holding actually outperforms its peers going forward, that should be a positive for the share price. I would further inform my view by checking insider buying and selling., among other things.

How Growth Rates Impact P/E Ratios

Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.

Ascom Holding's earnings per share fell by 17% in the last twelve months. And EPS is down 11% a year, over the last 5 years. This could justify a pessimistic P/E.

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. 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 investing in growth. That means taking on debt (or spending its cash).