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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we'll show how Gunnebo AB (publ)'s (STO:GUNN) P/E ratio could help you assess the value on offer. Based on the last twelve months, Gunnebo's P/E ratio is 19.87. That means that at current prices, buyers pay SEK19.87 for every SEK1 in trailing yearly profits.
See our latest analysis for Gunnebo
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 Gunnebo:
P/E of 19.87 = SEK27.05 ÷ SEK1.36 (Based on the year to March 2019.)
Is A High Price-to-Earnings Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. 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 Growth Rates Impact P/E Ratios
When earnings fall, the 'E' decreases, over time. That means even if the current P/E is low, it will increase over time if the share price stays flat. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
Gunnebo's earnings per share fell by 24% in the last twelve months. And over the longer term (3 years) earnings per share have decreased 19% annually. This growth rate might warrant a low P/E ratio.
Does Gunnebo Have A Relatively High Or Low P/E For Its Industry?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. You can see in the image below that the average P/E (17.1) for companies in the commercial services industry is lower than Gunnebo's P/E.
Its relatively high P/E ratio indicates that Gunnebo shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
Remember: P/E Ratios Don't Consider The Balance Sheet
Don't forget that the P/E ratio considers market capitalization. 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.