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Don't Sell Vonovia SE (ETR:VNA) Before You Read This

This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll show how you can use Vonovia SE's (ETR:VNA) P/E ratio to inform your assessment of the investment opportunity. Vonovia has a price to earnings ratio of 20.28, based on the last twelve months. That corresponds to an earnings yield of approximately 4.9%.

Check out our latest analysis for Vonovia

How Do I Calculate Vonovia's Price To Earnings Ratio?

The formula for P/E is:

Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)

Or for Vonovia:

P/E of 20.28 = €43.670 ÷ €2.153 (Based on the trailing twelve months to December 2019.)

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(Note: the above calculation results may not be precise due to rounding.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that buyers have to pay a higher price for each €1 the company has earned over the last year. 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'.

How Does Vonovia's P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. The image below shows that Vonovia has a higher P/E than the average (10.5) P/E for companies in the real estate industry.

XTRA:VNA Price Estimation Relative to Market April 24th 2020
XTRA:VNA Price Estimation Relative to Market April 24th 2020

Vonovia's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Shareholders are clearly optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

How Growth Rates Impact P/E Ratios

If earnings fall then in the future the 'E' will be lower. That means even if the current P/E is low, it will increase over time if the share price stays flat. Then, a higher P/E might scare off shareholders, pushing the share price down.

Vonovia saw earnings per share decrease by 52% last year. But over the longer term (5 years) earnings per share have increased by 6.7%. And it has shrunk its earnings per share by 24% per year over the last three years. This might lead to low expectations.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

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. 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).

Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.

So What Does Vonovia's Balance Sheet Tell Us?

Vonovia has net debt worth 98% of its market capitalization. This is enough debt that you'd have to make some adjustments before using the P/E ratio to compare it to a company with net cash.

The Bottom Line On Vonovia's P/E Ratio

Vonovia has a P/E of 20.3. That's higher than the average in its market, which is 17.2. With relatively high debt, and no earnings per share growth over twelve months, it's safe to say the market believes the company will improve its earnings growth in the future.

Investors have an opportunity when market expectations about a stock are wrong. 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 visual report on analyst forecasts could hold the key to an excellent investment decision.

But note: Vonovia may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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.

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. Thank you for reading.