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 Glanbia plc's (ISE:GL9) P/E ratio could help you assess the value on offer. Based on the last twelve months, Glanbia's P/E ratio is 13.44. That means that at current prices, buyers pay €13.44 for every €1 in trailing yearly profits.

See our latest analysis for Glanbia

How Do You Calculate A P/E Ratio?

The formula for P/E is:

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

Or for Glanbia:

P/E of 13.44 = €9.98 ÷ €0.74 (Based on the trailing twelve months to June 2019.)

Is A High Price-to-Earnings 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 isn't necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.

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

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 Glanbia has a lower P/E than the average (16.9) P/E for companies in the food industry.

Its relatively low P/E ratio indicates that Glanbia shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. 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. 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. Then, a lower P/E should attract more buyers, pushing the share price up.

Glanbia maintained roughly steady earnings over the last twelve months. But it has grown its earnings per share by 7.4% per year over the last five 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. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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.