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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 Aspo Oyj's (HEL:ASPO) P/E ratio could help you assess the value on offer. Aspo Oyj has a P/E ratio of 18.48, based on the last twelve months. In other words, at today's prices, investors are paying €18.48 for every €1 in prior year profit.
Check out our latest analysis for Aspo Oyj
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Aspo Oyj:
P/E of 18.48 = €7.7 ÷ €0.42 (Based on the trailing twelve months to June 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each €1 of company 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 Aspo Oyj Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio indicates whether the market has higher or lower expectations of a company. If you look at the image below, you can see Aspo Oyj has a lower P/E than the average (23.9) in the industrials industry classification.
Aspo Oyj's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Many investors like to buy stocks when the market is pessimistic about their prospects. You should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. Then, a higher P/E might scare off shareholders, pushing the share price down.
Aspo Oyj's earnings per share fell by 29% in the last twelve months. And it has shrunk its earnings per share by 3.1% per year over the last five years. This could justify a pessimistic P/E.
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. 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.
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 Aspo Oyj's P/E?
Net debt totals 77% of Aspo Oyj's market cap. If you want to compare its P/E ratio to other companies, you should absolutely keep in mind it has significant borrowings.