This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll look at Compagnie Générale des Établissements Michelin's (EPA:ML) P/E ratio and reflect on what it tells us about the company's share price. Based on the last twelve months, Compagnie Générale des Établissements Michelin's P/E ratio is 12.63. That corresponds to an earnings yield of approximately 7.9%.
How Do I Calculate Compagnie Générale des Établissements Michelin's Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Compagnie Générale des Établissements Michelin:
P/E of 12.63 = €117.5 ÷ €9.3 (Based on the year to December 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. When earnings grow, the 'E' increases, over time. That means unless the share price increases, the P/E will reduce in a few years. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Compagnie Générale des Établissements Michelin's earnings per share were pretty steady over the last year. But EPS is up 8.9% over the last 5 years.
Does Compagnie Générale des Établissements Michelin 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. You can see in the image below that the average P/E (7.7) for companies in the auto components industry is lower than Compagnie Générale des Établissements Michelin's P/E.
Compagnie Générale des Établissements Michelin's P/E tells us that market participants think the company will perform better than its industry peers, going forward. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should delve deeper. I like to check if company insiders have been buying or selling.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The 'Price' in P/E reflects the market capitalization of the company. So it won't reflect the advantage of cash, or disadvantage of debt. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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.
Compagnie Générale des Établissements Michelin's Balance Sheet
Compagnie Générale des Établissements Michelin's net debt is 18% of its market cap. That's enough debt to impact the P/E ratio a little; so keep it in mind if you're comparing it to companies without debt.
The Verdict On Compagnie Générale des Établissements Michelin's P/E Ratio
Compagnie Générale des Établissements Michelin has a P/E of 12.6. That's below the average in the FR market, which is 16.3. Since it only carries a modest debt load, it's likely the low expectations implied by the P/E ratio arise from the lack of recent earnings growth.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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 visual report on analyst forecasts could hold the key to an excellent investment decision.
But note: Compagnie Générale des Établissements Michelin may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
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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.