Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll show how you can use Legrand SA's (EPA:LR) P/E ratio to inform your assessment of the investment opportunity. Legrand has a price to earnings ratio of 20.82, based on the last twelve months. That corresponds to an earnings yield of approximately 4.8%.
How Do I Calculate Legrand's Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Legrand:
P/E of 20.82 = €62.22 ÷ €2.99 (Based on the year to June 2019.)
Is A High Price-to-Earnings Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing 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.
Does Legrand 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. As you can see below, Legrand has a higher P/E than the average company (17.6) in the electrical industry.
Its relatively high P/E ratio indicates that Legrand shareholders think it will perform better than other companies in its industry classification. 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
Earnings growth rates have a big influence on P/E ratios. Earnings growth means that in the future the 'E' will be higher. That means unless the share price increases, the P/E will reduce in a few years. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Legrand maintained roughly steady earnings over the last twelve months. But EPS is up 8.4% over the last 5 years.
Remember: P/E Ratios Don't Consider The Balance Sheet
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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).
So What Does Legrand's Balance Sheet Tell Us?
Net debt totals 16% of Legrand's market cap. This could bring some additional risk, and reduce the number of investment options for management; worth remembering if you compare its P/E to businesses without debt.
The Bottom Line On Legrand's P/E Ratio
Legrand's P/E is 20.8 which is above average (16.9) in its market. With modest debt relative to its size, and modest earnings growth, the market is likely expecting sustained long-term growth, if not a near-term improvement.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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 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.
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 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. Thank you for reading.