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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll look at Valeo SA’s (EPA:FR) P/E ratio and reflect on what it tells us about the company’s share price. Valeo has a price to earnings ratio of 7.14, based on the last twelve months. In other words, at today’s prices, investors are paying €7.14 for every €1 in prior year profit.

Check out our latest analysis for Valeo

How Do I Calculate A Price To Earnings Ratio?

The formula for price to earnings is:

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

Or for Valeo:

P/E of 7.14 = €25.07 ÷ €3.51 (Based on the year to June 2018.)

Is A High P/E Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each €1 of company earnings. That isn’t a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business’s prospects, relative to stocks with a lower P/E.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. When earnings grow, the ‘E’ increases, over time. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.

Valeo shrunk earnings per share by 17% over the last year. But EPS is up 17% over the last 5 years.

How Does Valeo’s P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. As you can see below Valeo has a P/E ratio that is fairly close for the average for the auto components industry, which is 7.1.

Valeo’s P/E tells us that market participants think its prospects are roughly in line with its industry. So if Valeo actually outperforms its peers going forward, that should be a positive for the share price. I inform my view byby checking management tenure and remuneration, among other things.

Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits

The ‘Price’ in P/E reflects the market capitalization of the company. That means it doesn’t take debt or cash into account. 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.

How Does Valeo’s Debt Impact Its P/E Ratio?

Net debt totals 41% of Valeo’s market cap. If you want to compare its P/E ratio to other companies, you should absolutely keep in mind it has significant borrowings.