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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll show how you can use nVent Electric plc’s (NYSE:NVT) P/E ratio to inform your assessment of the investment opportunity. nVent Electric has a P/E ratio of 12.33, based on the last twelve months. That corresponds to an earnings yield of approximately 8.1%.
Check out our latest analysis for nVent Electric
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for nVent Electric:
P/E of 12.33 = $21.98 ÷ $1.78 (Based on the year 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. 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 Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. 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. Then, a lower P/E should attract more buyers, pushing the share price up.
nVent Electric increased earnings per share by a whopping 28% last year.
How Does nVent Electric’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. If you look at the image below, you can see nVent Electric has a lower P/E than the average (14.6) in the electrical industry classification.
This suggests that market participants think nVent Electric 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.
Remember: P/E Ratios Don’t Consider The Balance Sheet
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. 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).