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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we'll show how NORMA Group SE's (ETR:NOEJ) P/E ratio could help you assess the value on offer. What is NORMA Group's P/E ratio? Well, based on the last twelve months it is 11.25. In other words, at today's prices, investors are paying €11.25 for every €1 in prior year profit.
View our latest analysis for NORMA Group
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 NORMA Group:
P/E of 11.25 = €27.86 ÷ €2.48 (Based on the trailing twelve months to June 2019.)
Is A High Price-to-Earnings Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.'
How Does NORMA Group's P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. If you look at the image below, you can see NORMA Group has a lower P/E than the average (13.5) in the machinery industry classification.
NORMA Group's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Many investors like to buy stocks when the market is pessimistic about their prospects. 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
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
NORMA Group saw earnings per share decrease by 34% last year. But it has grown its earnings per share by 7.9% per year over the last five years.
Remember: P/E Ratios Don't Consider The Balance Sheet
The 'Price' in P/E reflects the market capitalization of the company. That means it doesn't take debt or cash into account. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).