Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll apply a basic P/E ratio analysis to Galenica AG's (VTX:GALE), to help you decide if the stock is worth further research. Galenica has a P/E ratio of 16.57, based on the last twelve months. That means that at current prices, buyers pay CHF16.57 for every CHF1 in trailing yearly profits.
View our latest analysis for Galenica
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Galenica:
P/E of 16.57 = CHF52.6 ÷ CHF3.17 (Based on the year to June 2019.)
Is A High P/E 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.
How Does Galenica's P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. The image below shows that Galenica has a lower P/E than the average (21.2) P/E for companies in the healthcare industry.
Galenica's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Galenica, it's quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the 'E' increases, over time. And in that case, the P/E ratio itself will drop rather quickly. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Galenica increased earnings per share by a whopping 31% last year. And it has bolstered its earnings per share by 14% per year over the last five years. So we'd generally expect it to have a relatively high P/E ratio.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. In other words, it does not consider any debt or cash that the company may have on the balance sheet. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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).