Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at HOCHTIEF Aktiengesellschaft's (ETR:HOT) P/E ratio and reflect on what it tells us about the company's share price. Looking at earnings over the last twelve months, HOCHTIEF has a P/E ratio of 13.20. That corresponds to an earnings yield of approximately 7.6%.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for HOCHTIEF:
P/E of 13.20 = €111.50 ÷ €8.45 (Based on the year to September 2019.)
Is A High P/E 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.
How Does HOCHTIEF's P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. As you can see below, HOCHTIEF has a higher P/E than the average company (11.1) in the construction industry.
That means that the market expects HOCHTIEF will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. 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
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. Then, a lower P/E should attract more buyers, pushing the share price up.
HOCHTIEF's earnings per share grew by -4.0% in the last twelve months. And it has improved its earnings per share by 25% per year over the last three years.
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. 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).
HOCHTIEF's Balance Sheet
Since HOCHTIEF holds net cash of €587m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Verdict On HOCHTIEF's P/E Ratio
HOCHTIEF's P/E is 13.2 which is below average (20.3) in the DE market. Earnings improved over the last year. And the net cash position gives the company many options. So it's strange that the low P/E indicates low expectations. Given analysts are expecting further growth, one might have expected a higher P/E ratio. That may be worth further research.
Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
But note: HOCHTIEF 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 firstname.lastname@example.org. 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.