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Despite Its High P/E Ratio, Is SAF-Holland S.A. (FRA:SFQ) Still Undervalued?

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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we'll show how SAF-Holland S.A.'s (FRA:SFQ) P/E ratio could help you assess the value on offer. Based on the last twelve months, SAF-Holland's P/E ratio is 9.84. In other words, at today's prices, investors are paying €9.84 for every €1 in prior year profit.

See our latest analysis for SAF-Holland

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 SAF-Holland:

P/E of 9.84 = €10.44 ÷ €1.06 (Based on the trailing twelve months to December 2018.)

Is A High P/E Ratio Good?

A higher P/E ratio means that buyers have to pay a higher price for each €1 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 Growth Rates Impact P/E Ratios

If earnings fall then in the future the 'E' will be lower. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. Then, a higher P/E might scare off shareholders, pushing the share price down.

SAF-Holland increased earnings per share by an impressive 12% over the last twelve months. And earnings per share have improved by 7.6% annually, over the last five years. With that performance, you might expect an above average P/E ratio. In contrast, EPS has decreased by 2.4%, annually, over 3 years.

How Does SAF-Holland's P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. You can see in the image below that the average P/E (9.8) for companies in the auto components industry is roughly the same as SAF-Holland's P/E.

DB:SFQ Price Estimation Relative to Market, April 2nd 2019
DB:SFQ Price Estimation Relative to Market, April 2nd 2019

That indicates that the market expects SAF-Holland will perform roughly in line with other companies in its industry. If the company has better than average prospects, then the market might be underestimating it. I inform my view byby checking management tenure and remuneration, among other things.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

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. Theoretically, a business can improve its earnings (and produce a lower P/E in the future), by taking on debt (or spending its remaining cash).

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).

Is Debt Impacting SAF-Holland's P/E?

SAF-Holland has net debt worth 47% of its market capitalization. If you want to compare its P/E ratio to other companies, you should absolutely keep in mind it has significant borrowings.

The Bottom Line On SAF-Holland's P/E Ratio

SAF-Holland has a P/E of 9.8. That's below the average in the DE market, which is 19.1. The company hasn't stretched its balance sheet, and earnings growth was good last year. If the company can continue to grow earnings, then the current P/E may be unjustifiably low. Since analysts are predicting growth will continue, one might expect to see a higher P/E so it may be worth looking closer.

When the market is wrong about a stock, it gives savvy investors an opportunity. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

You might be able to find a better buy than SAF-Holland. 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.