This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll look at AST Groupe's (EPA:ASP) P/E ratio and reflect on what it tells us about the company's share price. What is AST Groupe's P/E ratio? Well, based on the last twelve months it is 6.24. In other words, at today's prices, investors are paying €6.24 for every €1 in prior year profit.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for AST Groupe:
P/E of 6.24 = €3.87 ÷ €0.62 (Based on the trailing twelve months to December 2018.)
Is A High Price-to-Earnings Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing 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 AST Groupe 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. The image below shows that AST Groupe has a lower P/E than the average (12.9) P/E for companies in the consumer durables industry.
Its relatively low P/E ratio indicates that AST Groupe shareholders think it will struggle to do as well as other companies in its industry classification. Many investors like to buy stocks when the market is pessimistic about their prospects. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
AST Groupe's earnings per share fell by 11% in the last twelve months. But EPS is up 84% over the last 5 years.
Remember: P/E Ratios Don't Consider The Balance Sheet
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. That means it doesn't take debt or cash into account. 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).
How Does AST Groupe's Debt Impact Its P/E Ratio?
Since AST Groupe holds net cash of €2.8m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Verdict On AST Groupe's P/E Ratio
AST Groupe trades on a P/E ratio of 6.2, which is below the FR market average of 16.8. Falling earnings per share are likely to be keeping potential buyers away, the relatively strong balance sheet will allow the company time to invest in growth. If it achieves that, then there's real potential that the low P/E could eventually indicate undervaluation.
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 visual report on analyst forecasts could hold the key to an excellent investment decision.
Of course you might be able to find a better stock than AST Groupe. 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 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. Thank you for reading.