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Despite Its High P/E Ratio, Is WashTec AG (ETR:WSU) Still Undervalued?

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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll show how you can use WashTec AG's (ETR:WSU) P/E ratio to inform your assessment of the investment opportunity. WashTec has a P/E ratio of 28.02, based on the last twelve months. That is equivalent to an earnings yield of about 3.6%.

See our latest analysis for WashTec

How Do You Calculate A P/E Ratio?

The formula for P/E is:

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

Or for WashTec:

P/E of 28.02 = EUR51.00 ÷ EUR1.82 (Based on the year to September 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each EUR1 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 WashTec Have A Relatively High Or Low P/E For Its Industry?

We can get an indication of market expectations by looking at the P/E ratio. As you can see below, WashTec has a higher P/E than the average company (15.3) in the machinery industry.

XTRA:WSU Price Estimation Relative to Market, February 26th 2020
XTRA:WSU Price Estimation Relative to Market, February 26th 2020

WashTec's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Shareholders are clearly optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

How Growth Rates Impact P/E Ratios

Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. 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.

WashTec shrunk earnings per share by 24% over the last year. But over the longer term (5 years) earnings per share have increased by 14%. And over the longer term (3 years) earnings per share have decreased 2.7% annually. This could justify a low P/E.

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

The 'Price' in P/E reflects the market capitalization of the company. That means it doesn't take debt or cash into account. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).

While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.

How Does WashTec's Debt Impact Its P/E Ratio?

WashTec's net debt is 6.7% of its market cap. It would probably trade on a higher P/E ratio if it had a lot of cash, but I doubt it is having a big impact.

The Verdict On WashTec's P/E Ratio

WashTec has a P/E of 28.0. That's higher than the average in its market, which is 20.2. 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.

Investors have an opportunity when market expectations about a stock are wrong. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine. 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 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 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.

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. Thank you for reading.