In This Article:
The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll look at Generic Sweden AB's (STO:GENI) P/E ratio and reflect on what it tells us about the company's share price. Generic Sweden has a P/E ratio of 15.54, based on the last twelve months. That corresponds to an earnings yield of approximately 6.4%.
Check out our latest analysis for Generic Sweden
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 Generic Sweden:
P/E of 15.54 = SEK10.50 ÷ SEK0.68 (Based on the trailing twelve months 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 is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
How Does Generic Sweden's P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. As you can see below Generic Sweden has a P/E ratio that is fairly close for the average for the it industry, which is 16.5.
Its P/E ratio suggests that Generic Sweden shareholders think that in the future it will perform about the same as other companies in its industry classification. 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. Earnings growth means that in the future the 'E' will be higher. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.
Notably, Generic Sweden grew EPS by a whopping 48% in the last year. And it has improved its earnings per share by 30% per year over the last three years. With that performance, I would expect it to have an above average P/E ratio.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
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.
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).