This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to STMicroelectronics N.V.'s (EPA:STM), to help you decide if the stock is worth further research. STMicroelectronics has a P/E ratio of 12.85, based on the last twelve months. In other words, at today's prices, investors are paying €12.85 for every €1 in prior year profit.
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How Do I Calculate STMicroelectronics's Price To Earnings 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 12.85 = $17.52 (Note: this is the share price in the reporting currency, namely, USD ) ÷ $1.36 (Based on the year to March 2019.)
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. 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.
Notably, STMicroelectronics grew EPS by a whopping 30% in the last year. And it has improved its earnings per share by 141% per year over the last three years. With that performance, I would expect it to have an above average P/E ratio.
Does STMicroelectronics Have A Relatively High Or Low P/E For Its Industry?
We can get an indication of market expectations by looking at the P/E ratio. If you look at the image below, you can see STMicroelectronics has a lower P/E than the average (24.5) in the semiconductor industry classification.
STMicroelectronics's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Many investors like to buy stocks when the market is pessimistic about their prospects. You should delve deeper. I like to check if company insiders have been buying or selling.
Remember: P/E Ratios Don't Consider The Balance Sheet
Don't forget that the P/E ratio considers market capitalization. That means it doesn't take debt or cash into account. 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).
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
Is Debt Impacting STMicroelectronics's P/E?
STMicroelectronics has net cash of US$241m. 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 trades on a P/E ratio of 12.8, which is below the FR market average of 17.4. The net cash position gives plenty of options to the business, and the recent improvement in EPS is good to see. The below average P/E ratio suggests that market participants don't believe the strong growth will continue.
Investors should be looking to buy stocks that the market is wrong about. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
Of course you might be able to find a better stock than STMicroelectronics. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.