U.S. Markets close in 2 hrs 19 mins

Here's How P/E Ratios Can Help Us Understand Garofalo Health Care S.p.A. (BIT:GHC)

Simply Wall St

This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll look at Garofalo Health Care S.p.A.'s (BIT:GHC) P/E ratio and reflect on what it tells us about the company's share price. Garofalo Health Care has a price to earnings ratio of 25.6, based on the last twelve months. In other words, at today's prices, investors are paying €25.6 for every €1 in prior year profit.

Check out our latest analysis for Garofalo Health Care

How Do You Calculate A P/E Ratio?

The formula for price to earnings is:

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

Or for Garofalo Health Care:

P/E of 25.6 = €4.24 ÷ €0.17 (Based on the year to December 2018.)

Is A High Price-to-Earnings Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.

Does Garofalo Health Care Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio essentially measures market expectations of a company. We can see in the image below that the average P/E (32.2) for companies in the healthcare industry is higher than Garofalo Health Care's P/E.

BIT:GHC Price Estimation Relative to Market, September 7th 2019

Its relatively low P/E ratio indicates that Garofalo Health Care shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Garofalo Health Care, it's quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. And in that case, the P/E ratio itself will drop rather quickly. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

Garofalo Health Care saw earnings per share decrease by 19% last year. But EPS is up 8.5% 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. 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.

Garofalo Health Care's Balance Sheet

Garofalo Health Care has net cash of €48m. This is fairly high at 14% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.

The Bottom Line On Garofalo Health Care's P/E Ratio

Garofalo Health Care trades on a P/E ratio of 25.6, which is above its market average of 16.3. Falling earnings per share is probably keeping traditional value investors away, but the healthy balance sheet means the company retains potential for future growth. If fails to eventuate, the current high P/E could prove to be temporary, as the share price falls.

Investors have an opportunity when market expectations about a stock are wrong. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. 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.

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.