Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!

Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll show how you can use Nolato AB (publ)'s (STO:NOLA B) P/E ratio to inform your assessment of the investment opportunity. Looking at earnings over the last twelve months, Nolato has a P/E ratio of 22.61. That is equivalent to an earnings yield of about 4.4%.

Check out our latest analysis for Nolato

How Do I Calculate Nolato's Price To Earnings Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)

Or for Nolato:

P/E of 22.61 = SEK556 ÷ SEK24.59 (Based on the trailing twelve months to March 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each SEK1 of company 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.

Does Nolato Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio indicates whether the market has higher or lower expectations of a company. As you can see below Nolato has a P/E ratio that is fairly close for the average for the industrials industry, which is 23.5.

Nolato's P/E tells us that market participants think its prospects are roughly in line with its industry. If the company has better than average prospects, then the market might be underestimating it. Checking factors such as director buying and selling. could help you form your own view on if that will happen.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. And in that case, the P/E ratio itself will drop rather quickly. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

Nolato saw earnings per share decrease by 3.4% last year. But it has grown its earnings per share by 17% per year over the last five years.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

The 'Price' in P/E reflects the market capitalization of the company. So it won't reflect the advantage of cash, or disadvantage of debt. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.