In This Article:
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 Boliden AB’s (STO:BOL) P/E ratio could help you assess the value on offer. Boliden has a price to earnings ratio of 7.34, based on the last twelve months. In other words, at today’s prices, investors are paying SEK7.34 for every SEK1 in prior year profit.
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How Do You Calculate Boliden’s P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Boliden:
P/E of 7.34 = SEK203.35 ÷ SEK27.71 (Based on the trailing twelve months to September 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 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 Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. When earnings grow, the ‘E’ increases, over time. That means even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
Most would be impressed by Boliden earnings growth of 18% in the last year. And its annual EPS growth rate over 5 years is 37%. This could arguably justify a relatively high P/E ratio.
How Does Boliden’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. We can see in the image below that the average P/E (9.3) for companies in the metals and mining industry is higher than Boliden’s P/E.
This suggests that market participants think Boliden will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The ‘Price’ in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.