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 HAEMATO AG’s (FRA:HAE) P/E ratio could help you assess the value on offer. HAEMATO has a P/E ratio of 11.18, based on the last twelve months. That corresponds to an earnings yield of approximately 8.9%.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for HAEMATO:
P/E of 11.18 = €5.1 ÷ €0.46 (Based on the year to June 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each €1 of company earnings. 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
Earnings growth rates have a big influence on P/E ratios. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.
HAEMATO increased earnings per share by an impressive 12% over the last twelve months. And it has bolstered its earnings per share by 2.2% per year over the last five years. This could arguably justify a relatively high P/E ratio.
How Does HAEMATO’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. We can see in the image below that the average P/E (26.8) for companies in the healthcare industry is higher than HAEMATO’s P/E.
HAEMATO’s P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with HAEMATO, 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.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
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.
Is Debt Impacting HAEMATO’s P/E?
HAEMATO has net debt worth just 8.8% of its market capitalization. So it doesn’t have as many options as it would with net cash, but its debt would not have much of an impact on its P/E ratio.
The Bottom Line On HAEMATO’s P/E Ratio
HAEMATO’s P/E is 11.2 which is below average (17.5) in the DE market. The EPS growth last year was strong, and debt levels are quite reasonable. If the company can continue to grow earnings, then the current P/E may be unjustifiably low.
When the market is wrong about a stock, it gives savvy investors an opportunity. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free visual report on analyst forecasts could hold they key to an excellent investment decision.
You might be able to find a better buy than HAEMATO. 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).
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.