This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we'll show how Compagnie d'Entreprises CFE SA's (EBR:CFEB) P/E ratio could help you assess the value on offer. Compagnie d'Entreprises CFE has a P/E ratio of 13.41, based on the last twelve months. That is equivalent to an earnings yield of about 7.5%.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Compagnie d'Entreprises CFE:
P/E of 13.41 = €70.700 ÷ €5.271 (Based on the year to December 2019.)
(Note: the above calculation results may not be precise due to rounding.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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 Compagnie d'Entreprises CFE Have A Relatively High Or Low P/E For Its Industry?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. As you can see below, Compagnie d'Entreprises CFE has a higher P/E than the average company (10.0) in the construction industry.
That means that the market expects Compagnie d'Entreprises CFE will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. So investors should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. That means unless the share price falls, the P/E will increase in a few years. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
Compagnie d'Entreprises CFE saw earnings per share decrease by 22% last year. And over the longer term (5 years) earnings per share have decreased 3.6% annually. This might lead to muted expectations.
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. In other words, it does not consider any debt or cash that the company may have on the balance sheet. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
Is Debt Impacting Compagnie d'Entreprises CFE's P/E?
Compagnie d'Entreprises CFE has net debt equal to 37% of its market cap. While it's worth keeping this in mind, it isn't a worry.
The Bottom Line On Compagnie d'Entreprises CFE's P/E Ratio
Compagnie d'Entreprises CFE has a P/E of 13.4. That's around the same as the average in the BE market, which is 13.8. When you consider the lack of EPS growth last year (along with some debt), it seems the market is optimistic about the future for the business.
When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. 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.
If you spot an error that warrants correction, please contact the editor at email@example.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.
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