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Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at Knorr-Bremse Aktiengesellschaft's (ETR:KBX) P/E ratio and reflect on what it tells us about the company's share price. Knorr-Bremse has a price to earnings ratio of 26.11, based on the last twelve months. That means that at current prices, buyers pay €26.11 for every €1 in trailing yearly profits.
View our latest analysis for Knorr-Bremse
How Do I Calculate Knorr-Bremse's Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Knorr-Bremse:
P/E of 26.11 = €96 ÷ €3.68 (Based on the trailing twelve months to December 2018.)
Is A High P/E Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. That isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. 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.
Most would be impressed by Knorr-Bremse earnings growth of 11% in the last year. And its annual EPS growth rate over 5 years is 13%. With that performance, you might expect an above average P/E ratio.
How Does Knorr-Bremse's P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. You can see in the image below that the average P/E (17.8) for companies in the machinery industry is lower than Knorr-Bremse's P/E.
That means that the market expects Knorr-Bremse will outperform other companies in its industry. Clearly the market expects growth, but it isn't guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
Don't forget that the P/E ratio considers market capitalization. That means it doesn't take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.