Yahoo Finance Read This Before You Buy Covestro AG (ETR:1COV) Because Of Its P/E Ratio
This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to Covestro AG's (ETR:1COV), to help you decide if the stock is worth further research. Looking at earnings over the last twelve months, Covestro has a P/E ratio of 11.97. That means that at current prices, buyers pay €11.97 for every €1 in trailing yearly profits.
See our latest analysis for Covestro
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Covestro:
P/E of 11.97 = EUR38.82 ÷ EUR3.24 (Based on the year to September 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each EUR1 the company has earned over the last year. 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 Covestro Have A Relatively High Or Low P/E For Its Industry?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Covestro has a lower P/E than the average (21.9) P/E for companies in the chemicals industry.
Covestro's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Many investors like to buy stocks when the market is pessimistic about their prospects. You should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. Earnings growth means that in the future the 'E' will be higher. 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.
Covestro's earnings per share fell by 72% in the last twelve months. But EPS is up 11% over the last 5 years.
Remember: P/E Ratios Don't Consider The Balance Sheet
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. So it won't reflect the advantage of cash, or disadvantage of debt. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on 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).
So What Does Covestro's Balance Sheet Tell Us?
Covestro has net debt worth just 7.6% of its market capitalization. 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 Bottom Line On Covestro's P/E Ratio
Covestro's P/E is 12.0 which is below average (20.8) in the DE market. Since it only carries a modest debt load, it's likely the low expectations implied by the P/E ratio arise from the lack of recent earnings growth.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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.
But note: Covestro 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.
