The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll look at DEUTZ Aktiengesellschaft's (ETR:DEZ) P/E ratio and reflect on what it tells us about the company's share price. DEUTZ has a price to earnings ratio of 7.12, based on the last twelve months. That means that at current prices, buyers pay €7.12 for every €1 in trailing yearly profits.

Check out our latest analysis for DEUTZ

How Do You Calculate A P/E Ratio?

The formula for price to earnings is:

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

Or for DEUTZ:

P/E of 7.12 = €5.25 ÷ €0.74 (Based on the year to June 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each €1 of company earnings. That isn't necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.

How Does DEUTZ'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. We can see in the image below that the average P/E (13.9) for companies in the machinery industry is higher than DEUTZ's P/E.

Its relatively low P/E ratio indicates that DEUTZ shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with DEUTZ, it's quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. 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.

DEUTZ shrunk earnings per share by 30% over the last year. But EPS is up 21% over the last 5 years.

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. Thus, the metric does not reflect cash or debt held by the company. 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).

Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.