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Do You Like Zardoya Otis, S.A. (BME:ZOT) At This P/E Ratio?

This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). To keep it practical, we'll show how Zardoya Otis, S.A.'s (BME:ZOT) P/E ratio could help you assess the value on offer. Looking at earnings over the last twelve months, Zardoya Otis has a P/E ratio of 20.76. In other words, at today's prices, investors are paying €20.76 for every €1 in prior year profit.

See our latest analysis for Zardoya Otis

How Do I Calculate A Price To Earnings Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)

Or for Zardoya Otis:

P/E of 20.76 = €6.31 ÷ €0.30 (Based on the year to May 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.

How Does Zardoya Otis'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 Zardoya Otis has a lower P/E than the average (22.8) P/E for companies in the machinery industry.

BME:ZOT Price Estimation Relative to Market, September 10th 2019
BME:ZOT Price Estimation Relative to Market, September 10th 2019

This suggests that market participants think Zardoya Otis will underperform other companies in its industry. Since the market seems unimpressed with Zardoya Otis, it's quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.

How Growth Rates Impact P/E Ratios

When earnings fall, the 'E' decreases, over time. That means even if the current P/E is low, it will increase over time if the share price stays flat. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.

Zardoya Otis shrunk earnings per share by 3.8% last year. And it has shrunk its earnings per share by 2.2% per year over the last three years. This growth rate might warrant a low P/E ratio. So you wouldn't expect a very high P/E.

Remember: P/E Ratios Don't Consider The Balance Sheet

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. That means it doesn't take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.

Zardoya Otis's Balance Sheet

Zardoya Otis has net cash of €58m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.

The Bottom Line On Zardoya Otis's P/E Ratio

Zardoya Otis trades on a P/E ratio of 20.8, which is above its market average of 16.7. The recent drop in earnings per share might keep value investors away, but the healthy balance sheet means the company retains potential for future growth. If fails to eventuate, the current high P/E could prove to be temporary, as the share price falls.

Investors should be looking to buy stocks that the market is wrong about. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

You might be able to find a better buy than Zardoya Otis. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

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.

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