Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. To keep it practical, we'll show how Nordea Bank Abp's (STO:NDA SE) P/E ratio could help you assess the value on offer. Looking at earnings over the last twelve months, Nordea Bank Abp has a P/E ratio of 14.28. That means that at current prices, buyers pay SEK14.28 for every SEK1 in trailing yearly profits.
How Do I Calculate Nordea Bank Abp's Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)
Or for Nordea Bank Abp:
P/E of 14.28 = €5.522 ÷ €0.387 (Based on the year to March 2020.)
(Note: the above calculation uses the share price in the reporting currency, namely EUR and the calculation results may not be precise due to rounding.)
Is A High Price-to-Earnings 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 is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
Does Nordea Bank Abp 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. The image below shows that Nordea Bank Abp has a higher P/E than the average (7.7) P/E for companies in the banks industry.
Its relatively high P/E ratio indicates that Nordea Bank Abp shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn't guaranteed. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
How Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. That means even if the current P/E is low, it will increase over time if the share price stays flat. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
Nordea Bank Abp shrunk earnings per share by 42% over the last year. And over the longer term (5 years) earnings per share have decreased 15% annually. This might lead to muted expectations.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
Don't forget that the P/E ratio considers market capitalization. That means it doesn't take debt or cash into account. 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.
How Does Nordea Bank Abp's Debt Impact Its P/E Ratio?
Net debt totals a substantial 646% of Nordea Bank Abp's market cap. This is a relatively high level of debt, so the stock probably deserves a relatively low P/E ratio. Keep that in mind when comparing it to other companies.
The Bottom Line On Nordea Bank Abp's P/E Ratio
Nordea Bank Abp trades on a P/E ratio of 14.3, which is below the SE market average of 17.2. When you consider that the company has significant debt, and didn't grow EPS last year, it isn't surprising that the market has muted expectations.
Investors have an opportunity when market expectations about a stock are wrong. 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 Nordea Bank Abp. So you may wish to see this free collection of other companies that have grown earnings strongly.
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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.