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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 FLSmidth & Co. A/S's (CPH:FLS) P/E ratio could help you assess the value on offer. FLSmidth has a P/E ratio of 15.95, based on the last twelve months. In other words, at today's prices, investors are paying DKK15.95 for every DKK1 in prior year profit.
View our latest analysis for FLSmidth
How Do I Calculate FLSmidth's Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for FLSmidth:
P/E of 15.95 = DKK262 ÷ DKK16.42 (Based on the year to March 2019.)
Is A High P/E Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. That isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
FLSmidth's 108% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. And earnings per share have improved by 19% annually, over the last three years. So you might say it really deserves to have an above-average P/E ratio.
How Does FLSmidth's P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. As you can see below FLSmidth has a P/E ratio that is fairly close for the average for the machinery industry, which is 16.
That indicates that the market expects FLSmidth will perform roughly in line with other companies in its industry. The company could surprise by performing better than average, in the future. Further research into factors such asmanagement tenure, could help you form your own view on whether that is likely.
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. 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.