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Despite Its High P/E Ratio, Is Hanza Holding AB (publ) (STO:HANZA) Still Undervalued?

Simply Wall St

Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll show how you can use Hanza Holding AB (publ)'s (STO:HANZA) P/E ratio to inform your assessment of the investment opportunity. Hanza Holding has a P/E ratio of 24.34, based on the last twelve months. In other words, at today's prices, investors are paying SEK24.34 for every SEK1 in prior year profit.

Check out our latest analysis for Hanza Holding

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 Hanza Holding:

P/E of 24.34 = SEK14.80 ÷ SEK0.61 (Based on the year to June 2019.)

Is A High P/E Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.

Does Hanza Holding 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. The image below shows that Hanza Holding has a higher P/E than the average (20.0) P/E for companies in the electronic industry.

OM:HANZA Price Estimation Relative to Market, October 13th 2019

Its relatively high P/E ratio indicates that Hanza Holding 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 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.

Hanza Holding's earnings per share fell by 40% in the last twelve months. And EPS is down 42% a year, over the last 3 years. This might lead to low 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. So it won't reflect the advantage of cash, or disadvantage of debt. 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.

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).

Hanza Holding's Balance Sheet

Hanza Holding's net debt equates to 44% of its market capitalization. While that's enough to warrant consideration, it doesn't really concern us.

The Bottom Line On Hanza Holding's P/E Ratio

Hanza Holding has a P/E of 24.3. That's higher than the average in its market, which is 16.7. With a bit of debt, but a lack of recent growth, it's safe to say the market is expecting improved profit performance from the company, in the next few years.

When the market is wrong about a stock, it gives savvy investors an opportunity. 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.

Of course you might be able to find a better stock than Hanza Holding. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.