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Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll show how you can use Tecnoglass Inc.'s (NASDAQ:TGLS) P/E ratio to inform your assessment of the investment opportunity. Tecnoglass has a price to earnings ratio of 29.2, based on the last twelve months. In other words, at today's prices, investors are paying $29.2 for every $1 in prior year profit.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Tecnoglass:
P/E of 29.2 = $7.03 ÷ $0.24 (Based on the trailing twelve months to December 2018.)
Is A High Price-to-Earnings 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. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.'
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. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. 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.
In the last year, Tecnoglass grew EPS like Taylor Swift grew her fan base back in 2010; the 63% gain was both fast and well deserved. Unfortunately, earnings per share are down 27% a year, over 5 years.
How Does Tecnoglass'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. You can see in the image below that the average P/E (26.3) for companies in the basic materials industry is lower than Tecnoglass's P/E.
That means that the market expects Tecnoglass will outperform other companies in its industry. 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.
Remember: P/E Ratios Don't Consider The Balance Sheet
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. So it won't reflect the advantage of cash, or disadvantage of debt. 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.
How Does Tecnoglass's Debt Impact Its P/E Ratio?
Tecnoglass has net debt worth 67% of its market capitalization. This is a reasonably significant level of debt -- all else being equal you'd expect a much lower P/E than if it had net cash.
The Verdict On Tecnoglass's P/E Ratio
Tecnoglass's P/E is 29.2 which is above average (18.1) in the US market. Its meaningful level of debt should warrant a lower P/E ratio, but the fast EPS growth is a positive. So despite the debt it is, perhaps, not unreasonable to see a 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 visual report on analyst forecasts could hold the key to an excellent investment decision.
You might be able to find a better buy than Tecnoglass. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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 firstname.lastname@example.org. 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.