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Should We Worry About EssilorLuxottica Société anonyme's (EPA:EL) P/E Ratio?

Simply Wall St

This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll show how you can use EssilorLuxottica Société anonyme's (EPA:EL) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, EssilorLuxottica Société anonyme's P/E ratio is 40.20. That is equivalent to an earnings yield of about 2.5%.

View our latest analysis for EssilorLuxottica Société anonyme

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

The formula for P/E is:

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

Or for EssilorLuxottica Société anonyme:

P/E of 40.20 = €135.05 ÷ €3.36 (Based on the year to June 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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 EssilorLuxottica Société anonyme's P/E Ratio Compare To Its Peers?

The P/E ratio indicates whether the market has higher or lower expectations of a company. You can see in the image below that the average P/E (30.5) for companies in the luxury industry is lower than EssilorLuxottica Société anonyme's P/E.

ENXTPA:EL Price Estimation Relative to Market, November 11th 2019

EssilorLuxottica Société anonyme'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

Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.

EssilorLuxottica Société anonyme's earnings per share fell by 37% in the last twelve months. And over the longer term (5 years) earnings per share have decreased 6.4% annually. This could justify a pessimistic P/E.

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. 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.

Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.

EssilorLuxottica Société anonyme's Balance Sheet

EssilorLuxottica Société anonyme's net debt is 4.8% of its 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 Bottom Line On EssilorLuxottica Société anonyme's P/E Ratio

EssilorLuxottica Société anonyme trades on a P/E ratio of 40.2, which is above its market average of 18.1. With some debt but no EPS growth last year, the market has high expectations of future profits.

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.

You might be able to find a better buy than EssilorLuxottica Société anonyme. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

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.