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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). To keep it practical, we'll show how SFD S.A.'s (WSE:SFD) P/E ratio could help you assess the value on offer. Based on the last twelve months, SFD's P/E ratio is 21.43. In other words, at today's prices, investors are paying PLN21.43 for every PLN1 in prior year profit.
View our latest analysis for SFD
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for SFD:
P/E of 21.43 = PLN0.44 ÷ PLN0.020 (Based on the trailing twelve months 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. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.'
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. When earnings grow, the 'E' increases, over time. That means unless the share price increases, the P/E will reduce in a few years. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
In the last year, SFD grew EPS like Taylor Swift grew her fan base back in 2010; the 151% gain was both fast and well deserved. The cherry on top is that the five year growth rate was an impressive 22% per year. With that kind of growth rate we would generally expect a high P/E ratio.
How Does SFD's P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. You can see in the image below that the average P/E (12.9) for companies in the retail distributors industry is lower than SFD's P/E.
That means that the market expects SFD will outperform other companies in its industry. Clearly the market expects growth, but it isn't guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.
Remember: P/E Ratios Don't Consider The Balance Sheet
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. That means it doesn't take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.