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Is Carl Zeiss Meditec AG's (ETR:AFX) High P/E Ratio A Problem For Investors?

Simply Wall St

Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at Carl Zeiss Meditec AG's (ETR:AFX) P/E ratio and reflect on what it tells us about the company's share price. Carl Zeiss Meditec has a P/E ratio of 60.33, based on the last twelve months. That corresponds to an earnings yield of approximately 1.7%.

See our latest analysis for Carl Zeiss Meditec

How Do I Calculate A Price To Earnings Ratio?

The formula for P/E is:

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

Or for Carl Zeiss Meditec:

P/E of 60.33 = €103.30 ÷ €1.71 (Based on the trailing twelve months to June 2019.)

Is A High Price-to-Earnings 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.

Does Carl Zeiss Meditec Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio essentially measures market expectations of a company. The image below shows that Carl Zeiss Meditec has a higher P/E than the average (33.9) P/E for companies in the medical equipment industry.

XTRA:AFX Price Estimation Relative to Market, September 21st 2019

Its relatively high P/E ratio indicates that Carl Zeiss Meditec shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn't guaranteed. So further research is always essential. I often monitor director buying and selling.

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. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

It's great to see that Carl Zeiss Meditec grew EPS by 23% in the last year. And it has bolstered its earnings per share by 11% per year over the last five years. So one might expect an above average P/E ratio.

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

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. So it won't reflect the advantage of cash, or disadvantage of debt. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).

So What Does Carl Zeiss Meditec's Balance Sheet Tell Us?

Carl Zeiss Meditec has net cash of €20m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.

The Bottom Line On Carl Zeiss Meditec's P/E Ratio

Carl Zeiss Meditec's P/E is 60.3 which is above average (20.2) in its market. With cash in the bank the company has plenty of growth options -- and it is already on the right track. Therefore it seems reasonable that the market would have relatively high expectations of the company

Investors should be looking to buy stocks that the market is wrong about. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. 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.

You might be able to find a better buy than Carl Zeiss Meditec. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

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.