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Here's How P/E Ratios Can Help Us Understand Prysmian S.p.A. (BIT:PRY)

This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). To keep it practical, we'll show how Prysmian S.p.A.'s (BIT:PRY) P/E ratio could help you assess the value on offer. Looking at earnings over the last twelve months, Prysmian has a P/E ratio of 25.95. That means that at current prices, buyers pay €25.95 for every €1 in trailing yearly profits.

Check out our latest analysis for Prysmian

How Do You Calculate A P/E Ratio?

The formula for P/E is:

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

Or for Prysmian:

P/E of 25.95 = €22.00 ÷ €0.85 (Based on the trailing twelve months to September 2019.)

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 Does Prysmian'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. If you look at the image below, you can see Prysmian has a lower P/E than the average (28.9) in the electrical industry classification.

BIT:PRY Price Estimation Relative to Market, December 23rd 2019
BIT:PRY Price Estimation Relative to Market, December 23rd 2019

This suggests that market participants think Prysmian will underperform other companies in its industry. Since the market seems unimpressed with Prysmian, it's quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.

How Growth Rates Impact P/E Ratios

When earnings fall, the 'E' decreases, over time. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.

Prysmian's earnings per share fell by 12% in the last twelve months. And it has shrunk its earnings per share by 11% per year over the last three years. This could justify a low P/E.

Remember: P/E Ratios Don't Consider The Balance Sheet

The 'Price' in P/E reflects the market capitalization of the company. That means it doesn't take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

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 Prysmian's Balance Sheet Tell Us?

Prysmian has net debt worth 50% 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 Bottom Line On Prysmian's P/E Ratio

Prysmian has a P/E of 26.0. That's higher than the average in its market, which is 18.4. With significant debt and no EPS growth last year, shareholders are betting on an improvement in earnings from the company.

Investors should be looking to buy stocks that the market is wrong about. 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. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

You might be able to find a better buy than Prysmian. 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).

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.

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. Thank you for reading.