Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll show how you can use Elos Medtech AB (publ)'s (STO:ELOS B) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Elos Medtech's P/E ratio is 25.52. That corresponds to an earnings yield of approximately 3.9%.
Check out our latest analysis for Elos Medtech
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Elos Medtech:
P/E of 25.52 = SEK110.50 ÷ SEK4.33 (Based on the trailing twelve months to September 2019.)
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'.
Does Elos Medtech Have A Relatively High Or Low P/E For Its Industry?
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 Elos Medtech has a lower P/E than the average (51.8) in the medical equipment industry classification.
Its relatively low P/E ratio indicates that Elos Medtech shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. Then, a higher P/E might scare off shareholders, pushing the share price down.
Notably, Elos Medtech grew EPS by a whopping 26% in the last year.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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.
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.