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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 Dr. Hönle AG's (ETR:HNL) P/E ratio to inform your assessment of the investment opportunity. Dr. Hönle has a price to earnings ratio of 17.03, based on the last twelve months. That means that at current prices, buyers pay €17.03 for every €1 in trailing yearly profits.
Check out our latest analysis for Dr. Hönle
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Dr. Hönle:
P/E of 17.03 = €56 ÷ €3.29 (Based on the year to March 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each €1 the company has earned over the last year. 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 Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the 'E' increases, over time. And in that case, the P/E ratio itself will drop rather quickly. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
Dr. Hönle's earnings per share grew by -4.3% in the last twelve months. And it has bolstered its earnings per share by 20% per year over the last five years.
Does Dr. Hönle Have A Relatively High Or Low P/E For Its Industry?
We can get an indication of market expectations by looking at the P/E ratio. If you look at the image below, you can see Dr. Hönle has a lower P/E than the average (38.7) in the electrical industry classification.
This suggests that market participants think Dr. Hönle will underperform other companies in its industry. Since the market seems unimpressed with Dr. Hönle, it's quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
The 'Price' in P/E reflects the market capitalization of the company. That means it doesn't take debt or cash into account. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).
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).