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Despite Its High P/E Ratio, Is Vestas Wind Systems A/S (CPH:VWS) Still Undervalued?

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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 Vestas Wind Systems A/S's (CPH:VWS) P/E ratio to inform your assessment of the investment opportunity. Looking at earnings over the last twelve months, Vestas Wind Systems has a P/E ratio of 26. That corresponds to an earnings yield of approximately 3.8%.

Check out our latest analysis for Vestas Wind Systems

How Do You Calculate Vestas Wind Systems's P/E Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)

Or for Vestas Wind Systems:

P/E of 26 = €79.84 (Note: this is the share price in the reporting currency, namely, EUR ) ÷ €3.07 (Based on the trailing twelve months to March 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each DKK1 of company earnings. 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 Vestas Wind Systems Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that Vestas Wind Systems has a higher P/E than the average (20.8) P/E for companies in the electrical industry.

CPSE:VWS Price Estimation Relative to Market, July 24th 2019
CPSE:VWS Price Estimation Relative to Market, July 24th 2019

Its relatively high P/E ratio indicates that Vestas Wind Systems shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn't guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. 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. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Vestas Wind Systems shrunk earnings per share by 23% over the last year. But it has grown its earnings per share by 55% per year over the last five years.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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.

So What Does Vestas Wind Systems's Balance Sheet Tell Us?

Vestas Wind Systems has net cash of €2.0b. This is fairly high at 13% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.

The Bottom Line On Vestas Wind Systems's P/E Ratio

Vestas Wind Systems's P/E is 26 which is above average (18.3) in its market. Falling earnings per share is probably keeping traditional value investors away, but the relatively strong balance sheet will allow the company time to invest in growth. Clearly, the high P/E indicates shareholders think it will!

Investors have an opportunity when market expectations about a stock are wrong. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E 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.