In This Article:
The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll look at Construcciones y Auxiliar de Ferrocarriles, S.A.'s (BME:CAF) P/E ratio and reflect on what it tells us about the company's share price. Based on the last twelve months, Construcciones y Auxiliar de Ferrocarriles's P/E ratio is 39.24. That means that at current prices, buyers pay €39.24 for every €1 in trailing yearly profits.
Check out our latest analysis for Construcciones y Auxiliar de Ferrocarriles
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 Construcciones y Auxiliar de Ferrocarriles:
P/E of 39.24 = €28.250 ÷ €0.720 (Based on the trailing twelve months to December 2019.)
(Note: the above calculation results may not be precise due to rounding.)
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 necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
Does Construcciones y Auxiliar de Ferrocarriles Have A Relatively High Or Low P/E For Its Industry?
We can get an indication of market expectations by looking at the P/E ratio. As you can see below, Construcciones y Auxiliar de Ferrocarriles has a higher P/E than the average company (19.7) in the machinery industry.
Construcciones y Auxiliar de Ferrocarriles's P/E tells us that market participants think the company will perform better than its industry peers, going forward. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
When earnings fall, the 'E' decreases, over time. That means unless the share price falls, the P/E will increase in a few years. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
Construcciones y Auxiliar de Ferrocarriles saw earnings per share decrease by 43% last year. And it has shrunk its earnings per share by 16% per year over the last five years. This might lead to muted expectations.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
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. 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).