Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll apply a basic P/E ratio analysis to Telia Company AB (publ)'s (STO:TELIA), to help you decide if the stock is worth further research. What is Telia Company's P/E ratio? Well, based on the last twelve months it is 21.56. That is equivalent to an earnings yield of about 4.6%.

View our latest analysis for Telia Company

How Do I Calculate Telia Company's Price To Earnings Ratio?

The formula for price to earnings is:

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

Or for Telia Company:

P/E of 21.56 = SEK42.96 ÷ SEK1.99 (Based on the trailing twelve months to June 2019.)

Is A High P/E Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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 Telia Company Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that Telia Company has a lower P/E than the average (24.1) P/E for companies in the telecom industry.

This suggests that market participants think Telia Company will underperform other companies in its industry. Since the market seems unimpressed with Telia Company, 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

Earnings growth rates have a big influence on P/E ratios. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

Telia Company shrunk earnings per share by 7.1% last year. But EPS is up 5.6% over the last 3 years. And EPS is down 9.6% a year, over the last 5 years. So we might expect a relatively low P/E.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

Don't forget that the P/E ratio considers market capitalization. That means it doesn't take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.