Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at Elektromont Spólka Akcyjna's (WSE:ELM) P/E ratio and reflect on what it tells us about the company's share price. Looking at earnings over the last twelve months, Elektromont Spólka Akcyjna has a P/E ratio of 8.49. That means that at current prices, buyers pay PLN8.49 for every PLN1 in trailing yearly profits.

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How Do I Calculate A Price To Earnings Ratio?

The formula for price to earnings is:

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

Or for Elektromont Spólka Akcyjna:

P/E of 8.49 = PLN0.44 ÷ PLN0.052 (Based on the year to December 2018.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each PLN1 of company earnings. 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

Earnings growth rates have a big influence on P/E ratios. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. That means unless the share price increases, the P/E will reduce in a few years. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

Notably, Elektromont Spólka Akcyjna grew EPS by a whopping 43% in the last year. But earnings per share are down 12% per year over the last five years.

Does Elektromont Spólka Akcyjna Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio essentially measures market expectations of a company. As you can see below, Elektromont Spólka Akcyjna has a higher P/E than the average company (7) in the construction industry.

That means that the market expects Elektromont Spólka Akcyjna will outperform other companies in its industry. Clearly the market expects growth, but it isn't guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.

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. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.

Is Debt Impacting Elektromont Spólka Akcyjna's P/E?

Elektromont Spólka Akcyjna has net cash of zł364k. This is fairly high at 13% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.

The Verdict On Elektromont Spólka Akcyjna's P/E Ratio

Elektromont Spólka Akcyjna's P/E is 8.5 which is below average (10.6) in the PL market. The net cash position gives plenty of options to the business, and the recent improvement in EPS is good to see. The below average P/E ratio suggests that market participants don't believe the strong growth will continue.

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. We don't have analyst forecasts, but shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.

You might be able to find a better buy than Elektromont Spólka Akcyjna. 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.