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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll show how you can use Catella AB (publ)'s (STO:CAT B) P/E ratio to inform your assessment of the investment opportunity. Catella has a P/E ratio of 18.63, based on the last twelve months. In other words, at today's prices, investors are paying SEK18.63 for every SEK1 in prior year profit.
Check out our latest analysis for Catella
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Catella:
P/E of 18.63 = SEK26.70 ÷ SEK1.43 (Based on the trailing twelve months to June 2019.)
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 Does Catella's P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. We can see in the image below that the average P/E (20.7) for companies in the capital markets industry is higher than Catella's P/E.
Catella's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Many investors like to buy stocks when the market is pessimistic about their prospects. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
How Growth Rates Impact P/E Ratios
When earnings fall, the 'E' decreases, over time. 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.
Catella's earnings per share fell by 58% in the last twelve months. But over the longer term (5 years) earnings per share have increased by 1.9%. And EPS is down 31% a year, over the last 3 years. This growth rate might warrant a low P/E ratio.
Remember: P/E Ratios Don't Consider The Balance Sheet
Don't forget that the P/E ratio considers market capitalization. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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).