The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll look at STMicroelectronics N.V.'s (EPA:STM) P/E ratio and reflect on what it tells us about the company's share price. STMicroelectronics has a price to earnings ratio of 20.65, based on the last twelve months. That corresponds to an earnings yield of approximately 4.8%.
How Do You Calculate STMicroelectronics's P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)
Or for STMicroelectronics:
P/E of 20.65 = €24.37 (Note: this is the share price in the reporting currency, namely, USD ) ÷ €1.18 (Based on the trailing twelve months to September 2019.)
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.
Does STMicroelectronics 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. If you look at the image below, you can see STMicroelectronics has a lower P/E than the average (26.6) in the semiconductor industry classification.
Its relatively low P/E ratio indicates that STMicroelectronics shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. 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
Probably the most important factor in determining what P/E a company trades on is the earnings growth. When earnings grow, the 'E' increases, over time. That means even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
STMicroelectronics's earnings per share fell by 10.0% in the last twelve months. But EPS is up 85% over the last 5 years.
Remember: P/E Ratios Don't Consider The Balance Sheet
Don't forget that the P/E ratio considers market capitalization. In other words, it does not consider any debt or cash that the company may have on the balance sheet. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on 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.
So What Does STMicroelectronics's Balance Sheet Tell Us?
STMicroelectronics has net cash of US$288m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Verdict On STMicroelectronics's P/E Ratio
STMicroelectronics has a P/E of 20.7. That's higher than the average in its market, which is 18.1. Falling earnings per share is probably keeping traditional value investors away, but the net cash position means the company has time to improve: and the high P/E suggests the market thinks it will.
Investors should be looking to buy stocks that the market is wrong about. 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.
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.
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