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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 apply a basic P/E ratio analysis to ScandBook Holding AB (publ)'s (STO:SBOK), to help you decide if the stock is worth further research. Based on the last twelve months, ScandBook Holding's P/E ratio is 7.8. In other words, at today's prices, investors are paying SEK7.8 for every SEK1 in prior year profit.

See our latest analysis for ScandBook Holding

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 ScandBook Holding:

P/E of 7.8 = SEK12.5 ÷ SEK1.6 (Based on the trailing twelve months to March 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. 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.'

How Growth Rates Impact P/E Ratios

When earnings fall, the 'E' decreases, over time. That means even if the current P/E is low, it will increase over time if the share price stays flat. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.

ScandBook Holding's earnings made like a rocket, taking off 265% last year.

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

One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. We can see in the image below that the average P/E (17.5) for companies in the commercial services industry is higher than ScandBook Holding's P/E.

Its relatively low P/E ratio indicates that ScandBook Holding shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with ScandBook Holding, it's quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

The 'Price' in P/E reflects the market capitalization of the company. So it won't reflect the advantage of cash, or disadvantage of debt. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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.

ScandBook Holding's Balance Sheet

ScandBook Holding's net debt is considerable, at 116% of its market cap. This level of debt justifies a relatively low P/E, so remain cognizant of the debt, if you're comparing it to other stocks.

The Bottom Line On ScandBook Holding's P/E Ratio

ScandBook Holding trades on a P/E ratio of 7.8, which is below the SE market average of 16.3. The company has a meaningful amount of debt on the balance sheet, but that should not eclipse the solid earnings growth. If it continues to grow, then the current low P/E may prove to be unjustified.

Investors have an opportunity when market expectations about a stock are wrong. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. We don't have analyst forecasts, but you might want to assess this data-rich visualization of earnings, revenue and cash flow.

Of course you might be able to find a better stock than ScandBook Holding. 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.