In This Article:
This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we'll show how Flügger group A/S's (CPH:FLUG B) P/E ratio could help you assess the value on offer. Flügger group has a price to earnings ratio of 27.15, based on the last twelve months. That corresponds to an earnings yield of approximately 3.7%.
View our latest analysis for Flügger group
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Flügger group:
P/E of 27.15 = DKK288 ÷ DKK10.61 (Based on the trailing twelve months to July 2019.)
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.'
Does Flügger group Have A Relatively High Or Low P/E For Its Industry?
We can get an indication of market expectations by looking at the P/E ratio. You can see in the image below that the average P/E (17.5) for companies in the chemicals industry is lower than Flügger group's P/E.
That means that the market expects Flügger group will outperform other companies in its industry. Clearly the market expects growth, but it isn't guaranteed. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. When earnings grow, the 'E' increases, over time. And in that case, the P/E ratio itself will drop rather quickly. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Flügger group increased earnings per share by a whopping 41% last year. And earnings per share have improved by 47% annually, over the last three years. I'd therefore be a little surprised if its P/E ratio was not relatively high. But earnings per share are down 16% per year over the last five years.
Remember: P/E Ratios Don't Consider The Balance Sheet
The 'Price' in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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).