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 DVS Technology AG's (FRA:DIS) P/E ratio to inform your assessment of the investment opportunity. DVS Technology has a price to earnings ratio of 26.46, based on the last twelve months. That means that at current prices, buyers pay €26.46 for every €1 in trailing yearly profits.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for DVS Technology:
P/E of 26.46 = €15.5 ÷ €0.59 (Based on the trailing twelve months to December 2018.)
Is A High P/E Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. That isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.
Does DVS Technology Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio indicates whether the market has higher or lower expectations of a company. You can see in the image below that the average P/E (14.8) for companies in the machinery industry is lower than DVS Technology's P/E.
Its relatively high P/E ratio indicates that DVS Technology 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 investors should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. That means unless the share price falls, the P/E will increase in a few years. Then, a higher P/E might scare off shareholders, pushing the share price down.
Notably, DVS Technology grew EPS by a whopping 42% in the last year. In contrast, EPS has decreased by 5.0%, annually, over 3 years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The 'Price' in P/E reflects the market capitalization of the company. That means it doesn't take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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.
Is Debt Impacting DVS Technology's P/E?
Net debt is 43% of DVS Technology's market cap. While it's worth keeping this in mind, it isn't a worry.
The Bottom Line On DVS Technology's P/E Ratio
DVS Technology has a P/E of 26.5. That's higher than the average in its market, which is 18.5. The company is not overly constrained by its modest debt levels, and its recent EPS growth is nothing short of stand-out. So to be frank we are not surprised it has 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. We don't have analyst forecasts, but you might want to assess this data-rich visualization of earnings, revenue and cash flow.
Of course you might be able to find a better stock than DVS Technology. So you may wish to see this free collection of other companies that have grown earnings strongly.
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 email@example.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.