Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll apply a basic P/E ratio analysis to Novozymes A/S's (CPH:NZYM B), to help you decide if the stock is worth further research. Looking at earnings over the last twelve months, Novozymes has a P/E ratio of 28.32. In other words, at today's prices, investors are paying DKK28.32 for every DKK1 in prior year profit.
How Do I Calculate Novozymes's Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Novozymes:
P/E of 28.32 = DKK314.6 ÷ DKK11.11 (Based on the trailing twelve months to December 2018.)
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 is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. When earnings grow, the 'E' increases, over time. That means unless the share price increases, the P/E will reduce in a few years. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Novozymes's earnings per share grew by -5.2% in the last twelve months. And its annual EPS growth rate over 5 years is 9.6%.
How Does Novozymes's P/E Ratio Compare To Its Peers?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. As you can see below, Novozymes has a higher P/E than the average company (17.8) in the chemicals industry.
Its relatively high P/E ratio indicates that Novozymes shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn't guaranteed. So further research is always essential. I often monitor director buying and selling.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
Don't forget that the P/E ratio considers market capitalization. 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.
So What Does Novozymes's Balance Sheet Tell Us?
Novozymes has net debt worth just 2.8% of its market capitalization. So it doesn't have as many options as it would with net cash, but its debt would not have much of an impact on its P/E ratio.
The Bottom Line On Novozymes's P/E Ratio
Novozymes trades on a P/E ratio of 28.3, which is above the DK market average of 17.9. Given the debt is only modest, and earnings are already moving in the right direction, it's not surprising that the market expects continued improvement.
When the market is wrong about a stock, it gives savvy investors an opportunity. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
Of course you might be able to find a better stock than Novozymes. 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.