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Is EssilorLuxottica Société anonyme's (EPA:EL) High P/E Ratio A Problem For Investors?

Simply Wall St

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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll look at EssilorLuxottica Société anonyme's (EPA:EL) P/E ratio and reflect on what it tells us about the company's share price. Based on the last twelve months, EssilorLuxottica Société anonyme's P/E ratio is 26.02. That corresponds to an earnings yield of approximately 3.8%.

View our latest analysis for EssilorLuxottica Société anonyme

How Do You Calculate EssilorLuxottica Société anonyme's P/E Ratio?

The formula for price to earnings is:

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

Or for EssilorLuxottica Société anonyme:

P/E of 26.02 = €108.5 ÷ €4.17 (Based on the year to December 2018.)

Is A High P/E 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. 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

P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the 'E' will be higher. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

EssilorLuxottica Société anonyme saw earnings per share decrease by 12% last year. But EPS is up 8.1% over the last 5 years.

Does EssilorLuxottica Société anonyme Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio essentially measures market expectations of a company. The image below shows that EssilorLuxottica Société anonyme has a P/E ratio that is roughly in line with the luxury industry average (26).

ENXTPA:EL Price Estimation Relative to Market, May 2nd 2019

That indicates that the market expects EssilorLuxottica Société anonyme will perform roughly in line with other companies in its industry. The company could surprise by performing better than average, in the future. Further research into factors such asmanagement tenure, could help you form your own view on whether that is likely.

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. 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.

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).

So What Does EssilorLuxottica Société anonyme's Balance Sheet Tell Us?

Net debt totals just 4.1% of EssilorLuxottica Société anonyme's market cap. It would probably trade on a higher P/E ratio if it had a lot of cash, but I doubt it is having a big impact.

The Verdict On EssilorLuxottica Société anonyme's P/E Ratio

EssilorLuxottica Société anonyme trades on a P/E ratio of 26, which is above the FR market average of 16.6. With a bit of debt, but a lack of recent growth, it's safe to say the market is expecting improved profit performance from the company, in the next few years.

Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

But note: EssilorLuxottica Société anonyme 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).

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 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. Thank you for reading.