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Should You Be Tempted To Sell ENAV S.p.A. (BIT:ENAV) Because Of Its P/E Ratio?

Simply Wall St

Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at ENAV S.p.A.'s (BIT:ENAV) P/E ratio and reflect on what it tells us about the company's share price. What is ENAV's P/E ratio? Well, based on the last twelve months it is 23.6. In other words, at today's prices, investors are paying €23.6 for every €1 in prior year profit.

View our latest analysis for ENAV

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 ENAV:

P/E of 23.6 = €4.98 ÷ €0.21 (Based on the year to March 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.

How Does ENAV's P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. The image below shows that ENAV has a P/E ratio that is roughly in line with the infrastructure industry average (22.3).

BIT:ENAV Price Estimation Relative to Market, August 1st 2019

Its P/E ratio suggests that ENAV shareholders think that in the future it will perform about the same as other companies in its industry classification. So if ENAV actually outperforms its peers going forward, that should be a positive for the share price. Further research into factors such as insider buying and selling, could help you form your own view on whether that is likely.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the 'E' will be higher. And in that case, the P/E ratio itself will drop rather quickly. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

It's great to see that ENAV grew EPS by 13% in the last year. And it has bolstered its earnings per share by 37% per year over the last five years. So one might expect an above average P/E ratio.

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. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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.

ENAV's Balance Sheet

The extra options and safety that comes with ENAV's €25m 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 ENAV's P/E Ratio

ENAV has a P/E of 23.6. That's higher than the average in its market, which is 15.7. Its strong balance sheet gives the company plenty of resources for extra growth, and it has already proven it can grow. So it does not seem strange that the P/E is above average.

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.' 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 be able to find a better stock than ENAV. 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 editorial-team@simplywallst.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. Thank you for reading.