The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we'll show how DocCheck AG's (ETR:AJ91) P/E ratio could help you assess the value on offer. Based on the last twelve months, DocCheck's P/E ratio is 18.86. In other words, at today's prices, investors are paying €18.86 for every €1 in prior year profit.

View our latest analysis for DocCheck

How Do I Calculate A Price To Earnings Ratio?

The formula for P/E is:

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

Or for DocCheck:

P/E of 18.86 = €8.6 ÷ €0.46 (Based on the trailing twelve months to December 2018.)

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 is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.

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

The P/E ratio essentially measures market expectations of a company. The image below shows that DocCheck has a higher P/E than the average (12.9) P/E for companies in the healthcare services industry.

DocCheck's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Shareholders are clearly optimistic, but the future is always uncertain. So further research is always essential. I often monitor director buying and selling.

How Growth Rates Impact P/E Ratios

If earnings fall then in the future the 'E' will be lower. That means unless the share price falls, the P/E will increase in a few years. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.

DocCheck saw earnings per share decrease by 5.7% last year. But EPS is up 16% over the last 5 years. And it has shrunk its earnings per share by 7.6% per year over the last three years. This growth rate might warrant a low P/E ratio. So we might expect a relatively low P/E.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

Don't forget that the P/E ratio considers market capitalization. That means it doesn't take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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.

How Does DocCheck's Debt Impact Its P/E Ratio?

With net cash of €10m, DocCheck has a very strong balance sheet, which may be important for its business. Having said that, at 24% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.