This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). To keep it practical, we'll show how Mermeren Kombinat AD's (ATH:MERKO) P/E ratio could help you assess the value on offer. Looking at earnings over the last twelve months, Mermeren Kombinat AD has a P/E ratio of 15.15. In other words, at today's prices, investors are paying €15.15 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 = Share Price ÷ Earnings per Share (EPS)
Or for Mermeren Kombinat AD:
P/E of 15.15 = EUR61.40 ÷ EUR4.05 (Based on the trailing twelve months to June 2019.)
Is A High P/E 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 Does Mermeren Kombinat AD's P/E Ratio Compare To Its Peers?
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 (12.8) for companies in the basic materials industry is lower than Mermeren Kombinat AD's P/E.
That means that the market expects Mermeren Kombinat AD will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. So further research is always essential. 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 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.
Most would be impressed by Mermeren Kombinat AD earnings growth of 14% in the last year. And earnings per share have improved by 39% annually, over the last five years. So one might expect an above average P/E ratio.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
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 expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
So What Does Mermeren Kombinat AD's Balance Sheet Tell Us?
The extra options and safety that comes with Mermeren Kombinat AD's €5.0m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Verdict On Mermeren Kombinat AD's P/E Ratio
Mermeren Kombinat AD trades on a P/E ratio of 15.2, which is below the GR market average of 17.3. The net cash position gives plenty of options to the business, and the recent improvement in EPS is good to see. The relatively low P/E ratio implies the market is pessimistic.
Investors should be looking to buy stocks that the market is wrong about. 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. We don't have analyst forecasts, but shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
But note: Mermeren Kombinat AD 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).
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.