The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we'll show how L'Air Liquide S.A.'s (EPA:AI) P/E ratio could help you assess the value on offer. L'Air Liquide S.A has a P/E ratio of 26.28, based on the last twelve months. In other words, at today's prices, investors are paying €26.28 for every €1 in prior year profit.
How Do You Calculate L'Air Liquide S.A's P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for L'Air Liquide S.A:
P/E of 26.28 = €119.30 ÷ €4.54 (Based on the year to June 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each €1 the company has earned over the last year. That isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.
How Does L'Air Liquide S.A's P/E Ratio Compare To Its Peers?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. The image below shows that L'Air Liquide S.A has a higher P/E than the average (23.0) P/E for companies in the chemicals industry.
That means that the market expects L'Air Liquide S.A will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. So further research is always essential. I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
L'Air Liquide S.A's earnings per share fell by 8.2% in the last twelve months. But it has grown its earnings per share by 2.8% per year over the last five years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
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.
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 L'Air Liquide S.A's P/E?
L'Air Liquide S.A's net debt equates to 27% of its market capitalization. While that's enough to warrant consideration, it doesn't really concern us.
The Verdict On L'Air Liquide S.A's P/E Ratio
L'Air Liquide S.A's P/E is 26.3 which is above average (17.1) in its market. With a bit of debt, but a lack of recent growth, it's safe to say the market is expecting improved profit performance from the company, in the next few years.
Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. 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 L'Air Liquide S.A. 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.