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Is Galp Energia, SGPS, S.A.'s (ELI:GALP) High P/E Ratio A Problem For Investors?

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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 show how you can use Galp Energia, SGPS, S.A.'s (ELI:GALP) P/E ratio to inform your assessment of the investment opportunity. Galp Energia SGPS has a P/E ratio of 18.69, based on the last twelve months. In other words, at today's prices, investors are paying €18.69 for every €1 in prior year profit.

See our latest analysis for Galp Energia SGPS

How Do You Calculate Galp Energia SGPS's P/E Ratio?

The formula for P/E is:

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

Or for Galp Energia SGPS:

P/E of 18.69 = €13.65 ÷ €0.73 (Based on the trailing twelve months to March 2019.)

Is A High P/E 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 Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

Galp Energia SGPS's earnings per share fell by 1.3% in the last twelve months. But over the longer term (5 years) earnings per share have increased by 34%.

How Does Galp Energia SGPS's P/E Ratio Compare To Its Peers?

The P/E ratio indicates whether the market has higher or lower expectations of a company. As you can see below, Galp Energia SGPS has a higher P/E than the average company (9.6) in the oil and gas industry.

ENXTLS:GALP Price Estimation Relative to Market, June 10th 2019
ENXTLS:GALP Price Estimation Relative to Market, June 10th 2019

That means that the market expects Galp Energia SGPS will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. So investors should delve deeper. I like to check if company insiders have been buying or 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. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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.

Galp Energia SGPS's Balance Sheet

Galp Energia SGPS's net debt is 14% of its market cap. That's enough debt to impact the P/E ratio a little; so keep it in mind if you're comparing it to companies without debt.

The Bottom Line On Galp Energia SGPS's P/E Ratio

Galp Energia SGPS trades on a P/E ratio of 18.7, which is above the PT market average of 14.1. With a bit of debt, but a lack of recent growth, it's safe to say the market is expecting improved profit performance from the company, in the next few years.

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.

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.

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 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. Thank you for reading.