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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 Tenaris S.A.’s (BIT:TEN) P/E ratio to inform your assessment of the investment opportunity. Tenaris has a price to earnings ratio of 18.13, based on the last twelve months. That corresponds to an earnings yield of approximately 5.5%.
How Do You Calculate Tenaris’s P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)
Or for Tenaris:
P/E of 18.13 = $12.45 (Note: this is the share price in the reporting currency, namely, USD ) ÷ $0.69 (Based on the year to September 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each €1 of company earnings. 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 Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. 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.
Notably, Tenaris grew EPS by a whopping 154% in the last year. And it has improved its earnings per share by 97% per year over the last three years. With that performance, I would expect it to have an above average P/E ratio. But earnings per share are down 35% per year over the last five years.
How Does Tenaris’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. We can see in the image below that the average P/E (23.6) for companies in the energy services industry is higher than Tenaris’s P/E.
Its relatively low P/E ratio indicates that Tenaris shareholders think it will struggle to do as well as other companies in its industry classification. Many investors like to buy stocks when the market is pessimistic about their prospects. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
Remember: P/E Ratios Don’t Consider The Balance Sheet
Don’t forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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.
Is Debt Impacting Tenaris’s P/E?
Since Tenaris holds net cash of US$222m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Bottom Line On Tenaris’s P/E Ratio
Tenaris’s P/E is 18.1 which is above average (14.6) in the IT market. With cash in the bank the company has plenty of growth options — and it is already on the right track. So it is not surprising the market is probably extrapolating recent growth well into the future, reflected in the relatively high P/E ratio.
When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. 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 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.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.