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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 SFS Group AG's (VTX:SFSN) P/E ratio could help you assess the value on offer. SFS Group has a price to earnings ratio of 15.53, based on the last twelve months. In other words, at today's prices, investors are paying CHF15.53 for every CHF1 in prior year profit.
See our latest analysis for SFS Group
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for SFS Group:
P/E of 15.53 = CHF79.85 ÷ CHF5.14 (Based on the trailing twelve months to December 2018.)
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. That isn't necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. When earnings grow, the 'E' increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
It's great to see that SFS Group grew EPS by 21% in the last year. And earnings per share have improved by 14% annually, over the last five years. So one might expect an above average P/E ratio.
How Does SFS Group'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 SFS Group has a lower P/E than the average (18.8) in the machinery industry classification.
Its relatively low P/E ratio indicates that SFS Group shareholders think it will struggle to do as well as other companies in its industry classification. 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.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don't forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. 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).