In This Article:
The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we'll show how European Eltech Public Joint Stock Company's (MCX:EELT) P/E ratio could help you assess the value on offer. European Eltech has a P/E ratio of 18.51, based on the last twelve months. That is equivalent to an earnings yield of about 5.4%.
Check out our latest analysis for European Eltech
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for European Eltech:
P/E of 18.51 = RUB10.18 ÷ RUB0.55 (Based on the year to December 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each RUB1 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 European Eltech Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. You can see in the image below that the average P/E (11.2) for companies in the construction industry is lower than European Eltech's P/E.
That means that the market expects European Eltech will outperform other companies in its industry. 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
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. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
In the last year, European Eltech grew EPS like Taylor Swift grew her fan base back in 2010; the 104% gain was both fast and well deserved. The cherry on top is that the five year growth rate was an impressive 19% per year. So I'd be surprised if the P/E ratio was not above average.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. In other words, it does not consider any debt or cash that the company may have on the balance sheet. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.