Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll show how you can use Clas Ohlson AB (publ)'s (STO:CLAS B) P/E ratio to inform your assessment of the investment opportunity. Looking at earnings over the last twelve months, Clas Ohlson has a P/E ratio of 66.08. That corresponds to an earnings yield of approximately 1.5%.

View our latest analysis for Clas Ohlson

How Do I Calculate A Price To Earnings Ratio?

The formula for P/E is:

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

Or for Clas Ohlson:

P/E of 66.08 = SEK95.95 ÷ SEK1.45 (Based on the trailing twelve months to July 2019.)

Is A High P/E Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each SEK1 of company earnings. 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.

Does Clas Ohlson 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. You can see in the image below that the average P/E (14.3) for companies in the specialty retail industry is a lot lower than Clas Ohlson's P/E.

That means that the market expects Clas Ohlson will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. So further research is always essential. I often monitor director buying and selling.

How Growth Rates Impact P/E Ratios

Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. That means even if the current P/E is low, it will increase over time if the share price stays flat. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.

Clas Ohlson shrunk earnings per share by 70% over the last year. And over the longer term (5 years) earnings per share have decreased 26% annually. This might lead to muted expectations.

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

The 'Price' in P/E reflects the market capitalization of the company. 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.

Clas Ohlson's Balance Sheet

Clas Ohlson's net debt is 0.2% 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 Verdict On Clas Ohlson's P/E Ratio

Clas Ohlson's P/E is 66.1 which suggests the market is more focussed on the future opportunity rather than the current level of earnings. With modest debt but no EPS growth in the last year, it's fair to say the P/E implies some optimism about future earnings, from the market.

When the market is wrong about a stock, it gives savvy investors an opportunity. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

Of course you might be able to find a better stock than Clas Ohlson. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.