Don’t Sell Avensia AB (publ) (STO:AVEN) Before You Read This

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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 Avensia AB (publ)’s (STO:AVEN) P/E ratio and reflect on what it tells us about the company’s share price. Based on the last twelve months, Avensia’s P/E ratio is 44.02. That corresponds to an earnings yield of approximately 2.3%.

See our latest analysis for Avensia

How Do You Calculate A P/E Ratio?

The formula for P/E is:

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

Or for Avensia:

P/E of 44.02 = SEK14.75 ÷ SEK0.34 (Based on the trailing twelve months to September 2018.)

Is A High P/E Ratio Good?

A higher P/E ratio means that buyers have to pay a higher price for each SEK1 the company has earned over the last year. That isn’t necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.

How Growth Rates Impact P/E Ratios

Probably the most important factor in determining what P/E a company trades on is the earnings growth. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. 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.

Notably, Avensia grew EPS by a whopping 66% in the last year. And earnings per share have improved by 15% annually, over the last five years. I’d therefore be a little surprised if its P/E ratio was not relatively high.

How Does Avensia’s P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. As you can see below, Avensia has a higher P/E than the average company (35) in the software industry.

Its relatively high P/E ratio indicates that Avensia shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn’t guaranteed. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

Remember: P/E Ratios Don’t Consider The Balance Sheet

It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. 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.

Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.

Avensia’s Balance Sheet

Since Avensia holds net cash of kr15m, it can spend on growth, justifying a higher P/E ratio than otherwise.

The Bottom Line On Avensia’s P/E Ratio

Avensia has a P/E of 44. That’s higher than the average in the SE market, which is 16.1. Its net cash position supports a higher P/E ratio, as does its solid recent earnings growth. So it does not seem strange that the P/E is above average.

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 report on the analyst consensus forecasts could help you make a master move on this stock.

But note: Avensia 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).

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.