In This Article:
The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we’ll show how Cembre SpA’s (BIT:CMB) P/E ratio could help you assess the value on offer. Based on the last twelve months, Cembre’s P/E ratio is 14.03. That means that at current prices, buyers pay €14.03 for every €1 in trailing yearly profits.
See our latest analysis for Cembre
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Cembre:
P/E of 14.03 = €20.45 ÷ €1.46 (Based on the year to September 2018.)
Is A High P/E Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each €1 the company has earned over the last year. 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
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. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
Notably, Cembre grew EPS by a whopping 32% in the last year. And its annual EPS growth rate over 5 years is 17%. So we’d generally expect it to have a relatively high P/E ratio.
How Does Cembre’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. We can see in the image below that the average P/E (17.7) for companies in the electrical industry is higher than Cembre’s P/E.
Its relatively low P/E ratio indicates that Cembre shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. You should delve deeper. I like to check if company insiders have been buying or selling.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The ‘Price’ in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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).