This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). To keep it practical, we'll show how Zardoya Otis, S.A.'s (BME:ZOT) P/E ratio could help you assess the value on offer. Looking at earnings over the last twelve months, Zardoya Otis has a P/E ratio of 20.76. In other words, at today's prices, investors are paying €20.76 for every €1 in prior year profit.
See our latest analysis for Zardoya Otis
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Zardoya Otis:
P/E of 20.76 = €6.31 ÷ €0.30 (Based on the year to May 2019.)
Is A High Price-to-Earnings Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. 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.
How Does Zardoya Otis'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 Zardoya Otis has a lower P/E than the average (22.8) P/E for companies in the machinery industry.
This suggests that market participants think Zardoya Otis will underperform other companies in its industry. Since the market seems unimpressed with Zardoya Otis, 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.
How Growth Rates Impact P/E Ratios
When earnings fall, the 'E' decreases, over time. That means even if the current P/E is low, it will increase over time if the share price stays flat. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
Zardoya Otis shrunk earnings per share by 3.8% last year. And it has shrunk its earnings per share by 2.2% per year over the last three years. This growth rate might warrant a low P/E ratio. So you wouldn't expect a very high P/E.
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. 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.
While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
Zardoya Otis's Balance Sheet
Zardoya Otis has net cash of €58m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.