This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we'll show how ELES Semiconductor Equipment S.p.A.'s (BIT:ELES) P/E ratio could help you assess the value on offer. What is ELES Semiconductor Equipment's P/E ratio? Well, based on the last twelve months it is 14.92. That means that at current prices, buyers pay €14.92 for every €1 in trailing yearly profits.
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for ELES Semiconductor Equipment:
P/E of 14.92 = €5.24 ÷ €0.35 (Based on the year to March 2019.)
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. 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 Does ELES Semiconductor Equipment'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 (24.9) for companies in the semiconductor industry is higher than ELES Semiconductor Equipment's P/E.
Its relatively low P/E ratio indicates that ELES Semiconductor Equipment shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. You should delve deeper. I like to check if company insiders have been buying or selling.
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. Then, a lower P/E should attract more buyers, pushing the share price up.
ELES Semiconductor Equipment's earnings made like a rocket, taking off 128% last year. The sweetener is that the annual five year growth rate of 32% is also impressive. With that kind of growth rate we would generally expect a high P/E ratio.
Remember: P/E Ratios Don't Consider The Balance Sheet
The 'Price' in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. 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).
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 ELES Semiconductor Equipment's Balance Sheet Tell Us?
Net debt is 44% of ELES Semiconductor Equipment's market cap. While that's enough to warrant consideration, it doesn't really concern us.
The Bottom Line On ELES Semiconductor Equipment's P/E Ratio
ELES Semiconductor Equipment has a P/E of 14.9. That's below the average in the IT market, which is 16.7. The company does have a little debt, and EPS growth was good last year. If the company can continue to grow earnings, then the current P/E may be unjustifiably low.
Investors have an opportunity when market expectations about a stock are wrong. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine.' We don't have analyst forecasts, but you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.
But note: ELES Semiconductor Equipment 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).
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.