The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll show how you can use InnoTec TSS AG's (FRA:TSS) P/E ratio to inform your assessment of the investment opportunity. InnoTec TSS has a price to earnings ratio of 11.47, based on the last twelve months. That is equivalent to an earnings yield of about 8.7%.
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 InnoTec TSS:
P/E of 11.47 = EUR9.50 ÷ EUR0.83 (Based on the trailing twelve months to June 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
Does InnoTec TSS Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. We can see in the image below that the average P/E (20.5) for companies in the building industry is higher than InnoTec TSS's P/E.
This suggests that market participants think InnoTec TSS will underperform other companies in its industry. Since the market seems unimpressed with InnoTec TSS, it's quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
When earnings fall, the 'E' decreases, over time. That means even if the current P/E is low, it will increase over time if the share price stays flat. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
InnoTec TSS's earnings per share fell by 17% in the last twelve months. And EPS is down 4.3% a year, over the last 5 years. This could justify a pessimistic P/E.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. Thus, the metric does not reflect cash or debt held by the company. 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 expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
How Does InnoTec TSS's Debt Impact Its P/E Ratio?
The extra options and safety that comes with InnoTec TSS's €4.7m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Verdict On InnoTec TSS's P/E Ratio
InnoTec TSS trades on a P/E ratio of 11.5, which is below the DE market average of 20.0. The recent drop in earnings per share would make investors cautious, but the net cash position means the company has time to improve: if so, the low P/E could be an opportunity.
Investors have an opportunity when market expectations about a stock are wrong. 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. Although we don't have analyst forecasts shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
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.
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.