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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 Lokum Deweloper S.A.'s (WSE:LKD) P/E ratio could help you assess the value on offer. Lokum Deweloper has a P/E ratio of 3.36, based on the last twelve months. That is equivalent to an earnings yield of about 30%.
Check out our latest analysis for Lokum Deweloper
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Lokum Deweloper:
P/E of 3.36 = PLN15.9 ÷ PLN4.74 (Based on the trailing twelve months to March 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each PLN1 of company earnings. 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.
Lokum Deweloper increased earnings per share by an impressive 21% over the last twelve months. And earnings per share have improved by 28% annually, over the last five years. This could arguably justify a relatively high P/E ratio.
How Does Lokum Deweloper's P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Lokum Deweloper has a lower P/E than the average (8.2) P/E for companies in the real estate industry.
Its relatively low P/E ratio indicates that Lokum Deweloper shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Lokum Deweloper, 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.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. In other words, it does not consider any debt or cash that the company may have on the balance sheet. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.