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Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll apply a basic P/E ratio analysis to Sulzer Ltd's (VTX:SUN), to help you decide if the stock is worth further research. What is Sulzer's P/E ratio? Well, based on the last twelve months it is 26.68. That corresponds to an earnings yield of approximately 3.7%.
Check out our latest analysis for Sulzer
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Sulzer:
P/E of 26.68 = CHF95 ÷ CHF3.56 (Based on the trailing twelve months to December 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. 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. Then, a lower P/E should attract more buyers, pushing the share price up.
It's nice to see that Sulzer grew EPS by a stonking 46% in the last year. And its annual EPS growth rate over 3 years is 18%. I'd therefore be a little surprised if its P/E ratio was not relatively high. In contrast, EPS has decreased by 7.1%, annually, over 5 years.
How Does Sulzer'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 Sulzer has a higher P/E than the average (18.8) P/E for companies in the machinery industry.
That means that the market expects Sulzer will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
The 'Price' in P/E reflects the market capitalization of the company. So it won't reflect the advantage of cash, or disadvantage of debt. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.