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 Topdanmark A/S's (CPH:TOP), to help you decide if the stock is worth further research. Topdanmark has a P/E ratio of 18.58, based on the last twelve months. That means that at current prices, buyers pay DKK18.58 for every DKK1 in trailing yearly profits.
How Do I Calculate Topdanmark's Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Topdanmark:
P/E of 18.58 = DKK332.6 ÷ DKK17.9 (Based on the trailing twelve months to June 2019.)
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 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.
Does Topdanmark Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio indicates whether the market has higher or lower expectations of a company. As you can see below, Topdanmark has a higher P/E than the average company (13.2) in the insurance industry.
That means that the market expects Topdanmark will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. So further research is always essential. I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. That means even if the current P/E is high, it will reduce over time if the share price stays flat. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Topdanmark increased earnings per share by 5.5% last year. And earnings per share have improved by 4.4% annually, over the last five years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The 'Price' in P/E reflects the market capitalization of the company. That means it doesn't take debt or cash into account. 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).
How Does Topdanmark's Debt Impact Its P/E Ratio?
The extra options and safety that comes with Topdanmark's ø731m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Bottom Line On Topdanmark's P/E Ratio
Topdanmark's P/E is 18.6 which is above average (15.7) in its market. Recent earnings growth wasn't bad. Also positive, the relatively strong balance sheet will allow for investment in growth -- and the P/E indicates shareholders that will happen!
Investors should be looking to buy stocks that the market is wrong about. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine.' So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
Of course you might be able to find a better stock than Topdanmark. So you may wish to see this free collection of other companies that have grown earnings strongly.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at email@example.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.