The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to MLS Innovation Inc.'s (ATH:MLS), to help you decide if the stock is worth further research. Looking at earnings over the last twelve months, MLS Innovation has a P/E ratio of 37.98. That corresponds to an earnings yield of approximately 2.6%.
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View our latest analysis for MLS Innovation
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for MLS Innovation:
P/E of 37.98 = €5.04 ÷ €0.13 (Based on the trailing twelve months to December 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each €1 of company earnings. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
How Growth Rates Impact P/E Ratios
When earnings fall, the 'E' decreases, over time. That means unless the share price falls, the P/E will increase in a few years. Then, a higher P/E might scare off shareholders, pushing the share price down.
MLS Innovation's earnings per share fell by 14% in the last twelve months. But EPS is up 7.1% over the last 5 years. And EPS is down 7.1% a year, over the last 3 years. This might lead to low expectations.
How Does MLS Innovation's P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that MLS Innovation has a higher P/E than the average (26.1) P/E for companies in the software industry.
Its relatively high P/E ratio indicates that MLS Innovation shareholders think it will perform better than other companies in its industry classification. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don't forget that the P/E ratio considers market capitalization. So it won't reflect the advantage of cash, or disadvantage of debt. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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).