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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll show how you can use Avio S.p.A.'s (BIT:AVIO) P/E ratio to inform your assessment of the investment opportunity. Avio has a P/E ratio of 13.06, based on the last twelve months. In other words, at today's prices, investors are paying €13.06 for every €1 in prior year profit.
See our latest analysis for Avio
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Avio:
P/E of 13.06 = €12.06 ÷ €0.92 (Based on the year to December 2018.)
Is A High P/E Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each €1 the company has earned over the last year. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
Does Avio Have A Relatively High Or Low P/E For Its Industry?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. If you look at the image below, you can see Avio has a lower P/E than the average (21.6) in the aerospace & defense industry classification.
Avio's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Avio, it's quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. 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.
Avio increased earnings per share by an impressive 19% over the last twelve months. And it has bolstered its earnings per share by 121% per year over the last five years. So one might expect an above average P/E ratio.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. So it won't reflect the advantage of cash, or disadvantage of debt. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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).