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Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll apply a basic P/E ratio analysis to RHÖN-KLINIKUM Aktiengesellschaft's (FRA:RHK), to help you decide if the stock is worth further research. Based on the last twelve months, RHÖN-KLINIKUM's P/E ratio is 36.34. That corresponds to an earnings yield of approximately 2.8%.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for RHÖN-KLINIKUM:
P/E of 36.34 = €26.6 ÷ €0.73 (Based on the year to December 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. That isn't necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
How Growth Rates Impact P/E Ratios
If earnings fall then in the future the 'E' will be lower. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
RHÖN-KLINIKUM increased earnings per share by a whopping 39% last year. And it has bolstered its earnings per share by 3.1% per year over the last five years. I'd therefore be a little surprised if its P/E ratio was not relatively high. Unfortunately, earnings per share are down 15% a year, over 3 years.
Does RHÖN-KLINIKUM Have A Relatively High Or Low P/E For Its Industry?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. The image below shows that RHÖN-KLINIKUM has a P/E ratio that is roughly in line with the healthcare industry average (34.8).
That indicates that the market expects RHÖN-KLINIKUM will perform roughly in line with other companies in its industry. So if RHÖN-KLINIKUM actually outperforms its peers going forward, that should be a positive for the share price. Further research into factors such asmanagement tenure, could help you form your own view on whether that is likely.
Remember: P/E Ratios Don't Consider The Balance Sheet
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. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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.
How Does RHÖN-KLINIKUM's Debt Impact Its P/E Ratio?
RHÖN-KLINIKUM has net cash of €157m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Bottom Line On RHÖN-KLINIKUM's P/E Ratio
RHÖN-KLINIKUM trades on a P/E ratio of 36.3, which is above the DE market average of 20.3. Its net cash position is the cherry on top of its superb EPS growth. So based on this analysis we'd expect RHÖN-KLINIKUM to have a high P/E ratio.
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 visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
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 firstname.lastname@example.org. 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.