This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll look at Bayerische Motoren Werke Aktiengesellschaft's (ETR:BMW) P/E ratio and reflect on what it tells us about the company's share price. Bayerische Motoren Werke has a P/E ratio of 9.03, based on the last twelve months. In other words, at today's prices, investors are paying €9.03 for every €1 in prior year profit.
How Do I Calculate Bayerische Motoren Werke's Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Bayerische Motoren Werke:
P/E of 9.03 = EUR65.86 ÷ EUR7.29 (Based on the year to September 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each EUR1 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'.
Does Bayerische Motoren Werke Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. The image below shows that Bayerische Motoren Werke has a lower P/E than the average (10.2) P/E for companies in the auto industry.
Bayerische Motoren Werke's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Bayerische Motoren Werke, it's quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
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.
Bayerische Motoren Werke shrunk earnings per share by 43% over the last year. And EPS is down 3.8% a year, over the last 5 years. This growth rate might warrant a below average P/E ratio.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
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. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
How Does Bayerische Motoren Werke's Debt Impact Its P/E Ratio?
Net debt totals a substantial 228% of Bayerische Motoren Werke's market cap. This is a relatively high level of debt, so the stock probably deserves a relatively low P/E ratio. Keep that in mind when comparing it to other companies.
The Verdict On Bayerische Motoren Werke's P/E Ratio
Bayerische Motoren Werke has a P/E of 9.0. That's below the average in the DE market, which is 21.1. Given meaningful debt, and a lack of recent growth, the market looks to be extrapolating this recent performance; reflecting low expectations for the future.
Investors have an opportunity when market expectations about a stock are wrong. 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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