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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll look at Prada S.p.A.'s (HKG:1913) P/E ratio and reflect on what it tells us about the company's share price. Prada has a P/E ratio of 32.9, based on the last twelve months. That is equivalent to an earnings yield of about 3.0%.

See our latest analysis for Prada

How Do You Calculate Prada's P/E Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)

Or for Prada:

P/E of 32.9 = €2.64 (Note: this is the share price in the reporting currency, namely, EUR ) ÷ €0.080 (Based on the year to December 2018.)

Is A High P/E Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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

If earnings fall then in the future the 'E' will be lower. That means unless the share price falls, the P/E will increase in a few years. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.

Prada shrunk earnings per share by 14% over the last year. And over the longer term (5 years) earnings per share have decreased 24% annually. This might lead to muted expectations.

How Does Prada's P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. As you can see below, Prada has a much higher P/E than the average company (10.5) in the luxury industry.

Its relatively high P/E ratio indicates that Prada 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. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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.

Is Debt Impacting Prada's P/E?

Prada has net debt worth just 4.4% of its market capitalization. So it doesn't have as many options as it would with net cash, but its debt would not have much of an impact on its P/E ratio.

The Verdict On Prada's P/E Ratio

Prada has a P/E of 32.9. That's higher than the average in the HK market, which is 12.2. 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 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 Prada. 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.