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 Entersoft A.E.'s (ATH:ENTER) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Entersoft A.E's P/E ratio is 16.98. In other words, at today's prices, investors are paying €16.98 for every €1 in prior year profit.
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Entersoft A.E:
P/E of 16.98 = EUR6.80 ÷ EUR0.40 (Based on the trailing twelve months to June 2019.)
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 necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
How Does Entersoft A.E's P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. We can see in the image below that the average P/E (24.5) for companies in the software industry is higher than Entersoft A.E's P/E.
Its relatively low P/E ratio indicates that Entersoft A.E shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. 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. Earnings growth means that in the future the 'E' will be higher. That means even if the current P/E is high, it will reduce over time if the share price stays flat. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Entersoft A.E's earnings made like a rocket, taking off 62% last year. And earnings per share have improved by 15% annually, over the last three years. So we'd absolutely expect it to have a relatively high P/E ratio.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. In other words, it does not consider any debt or cash that the company may have on the balance sheet. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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).
Is Debt Impacting Entersoft A.E's P/E?
The extra options and safety that comes with Entersoft A.E's €2.8m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Bottom Line On Entersoft A.E's P/E Ratio
Entersoft A.E has a P/E of 17.0. That's around the same as the average in the GR market, which is 17.5. The excess cash it carries is the gravy on top its fast EPS growth. So based on this analysis we'd expect Entersoft A.E to have a higher P/E ratio.
Investors should be looking to buy stocks that the market is wrong about. 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. We don't have analyst forecasts, but you might want to assess this data-rich visualization of earnings, revenue and cash flow.
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.
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.