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Don't Sell Knorr-Bremse Aktiengesellschaft (ETR:KBX) Before You Read This

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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll look at Knorr-Bremse Aktiengesellschaft's (ETR:KBX) P/E ratio and reflect on what it tells us about the company's share price. Based on the last twelve months, Knorr-Bremse's P/E ratio is 26.10. That means that at current prices, buyers pay €26.10 for every €1 in trailing yearly profits.

Check out our latest analysis for Knorr-Bremse

How Do I Calculate Knorr-Bremse's Price To Earnings Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)

Or for Knorr-Bremse:

P/E of 26.10 = €90.75 ÷ €3.48 (Based on the trailing twelve months to September 2019.)

Is A High P/E Ratio Good?

A higher P/E ratio means that buyers have to pay a higher price for each €1 the company has earned over the last year. 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.

Does Knorr-Bremse Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio essentially measures market expectations of a company. You can see in the image below that the average P/E (16.3) for companies in the machinery industry is lower than Knorr-Bremse's P/E.

XTRA:KBX Price Estimation Relative to Market, January 1st 2020
XTRA:KBX Price Estimation Relative to Market, January 1st 2020

Its relatively high P/E ratio indicates that Knorr-Bremse shareholders think it will perform better than other companies in its industry classification. The market is optimistic about the future, but that doesn't guarantee future growth. 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. When earnings grow, the 'E' increases, over time. That means even if the current P/E is high, it will reduce over time if the share price stays flat. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

Knorr-Bremse saw earnings per share decrease by 14% last year. But EPS is up 3.0% over the last 5 years.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

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. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).

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.

Knorr-Bremse's Balance Sheet

Knorr-Bremse has net cash of €194m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.

The Bottom Line On Knorr-Bremse's P/E Ratio

Knorr-Bremse's P/E is 26.1 which is above average (20.8) in its market. Falling earnings per share is probably keeping traditional value investors away, but the net cash position means the company has time to improve: and the high P/E suggests the market thinks it will.

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 report on the analyst consensus forecasts could help you make a master move on this stock.

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 editorial-team@simplywallst.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.