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 Gränges AB (publ)'s (STO:GRNG) P/E ratio could help you assess the value on offer. What is Gränges's P/E ratio? Well, based on the last twelve months it is 10.53. That means that at current prices, buyers pay SEK10.53 for every SEK1 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 Gränges:
P/E of 10.53 = SEK97.80 ÷ SEK9.29 (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 SEK1 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 Gränges'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 Gränges has a P/E ratio that is fairly close for the average for the metals and mining industry, which is 10.9.
Gränges's P/E tells us that market participants think its prospects are roughly in line with its industry. The company could surprise by performing better than average, in the future. I would further inform my view by checking insider buying and selling., among other things.
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. When earnings grow, the 'E' increases, over time. That means unless the share price increases, the P/E will reduce in a few years. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Gränges had pretty flat EPS growth in the last year. But it has grown its earnings per share by 12% per year over the last five years.
Remember: P/E Ratios Don't Consider The Balance Sheet
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. So it won't reflect the advantage of cash, or disadvantage of debt. 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).
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.
Gränges's Balance Sheet
Gränges's net debt equates to 40% of its market capitalization. While it's worth keeping this in mind, it isn't a worry.
The Verdict On Gränges's P/E Ratio
Gränges has a P/E of 10.5. That's below the average in the SE market, which is 19.4. The company hasn't stretched its balance sheet, and earnings are improving. The P/E ratio implies the market is cautious about longer term prospects.
Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. 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.
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.
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