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Is Aker ASA's (OB:AKER) High P/E Ratio A Problem For Investors?

Simply Wall St

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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll show how you can use Aker ASA's (OB:AKER) P/E ratio to inform your assessment of the investment opportunity. Looking at earnings over the last twelve months, Aker has a P/E ratio of 76.66. That means that at current prices, buyers pay NOK76.66 for every NOK1 in trailing yearly profits.

Check out our latest analysis for Aker

How Do I Calculate Aker's Price To Earnings Ratio?

The formula for price to earnings is:

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

Or for Aker:

P/E of 76.66 = NOK483 ÷ NOK6.3 (Based on the year to December 2018.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that buyers have to pay a higher price for each NOK1 the company has earned over the last year. 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.'

How Does Aker'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 Aker has a significantly higher P/E than the average (13.8) P/E for companies in the diversified financial industry.

OB:AKER Price Estimation Relative to Market, July 19th 2019

Its relatively high P/E ratio indicates that Aker shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. 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

When earnings fall, the 'E' decreases, over time. That means unless the share price falls, the P/E will increase in a few years. Then, a higher P/E might scare off shareholders, pushing the share price down.

Aker shrunk earnings per share by 23% over the last year. But over the longer term (5 years) earnings per share have increased by 9.4%. And over the longer term (3 years) earnings per share have decreased 28% annually. This growth rate might warrant a low P/E ratio.

Remember: P/E Ratios Don't Consider The Balance Sheet

The 'Price' in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. 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.

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.

Aker's Balance Sheet

Aker's net debt is 58% of its market cap. This is a reasonably significant level of debt -- all else being equal you'd expect a much lower P/E than if it had net cash.

The Bottom Line On Aker's P/E Ratio

Aker's P/E is 76.7 which suggests the market is more focussed on the future opportunity rather than the current level of earnings. With relatively high debt, and no earnings per share growth over twelve months, it's safe to say the market believes the company will improve its earnings growth in the future.

Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.

But note: Aker may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.