This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll show how you can use Inclam, S.A.'s (BME:INC) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Inclam's P/E ratio is 25.86. That is equivalent to an earnings yield of about 3.9%.
View our latest analysis for Inclam
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Inclam:
P/E of 25.86 = €1.70 ÷ €0.07 (Based on the trailing twelve months to December 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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 Does Inclam's P/E Ratio Compare To Its Peers?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. The image below shows that Inclam has a higher P/E than the average (15.8) P/E for companies in the commercial services industry.
Its relatively high P/E ratio indicates that Inclam shareholders think it will perform better than other companies in its industry classification. 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.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. That means even if the current P/E is high, it will reduce over time if the share price stays flat. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Inclam increased earnings per share by a whopping 32% last year. And its annual EPS growth rate over 5 years is 2.1%. I'd therefore be a little surprised if its P/E ratio was not relatively high.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. So it won't reflect the advantage of cash, or disadvantage of debt. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.