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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 apply a basic P/E ratio analysis to Interparfums SA's (EPA:ITP), to help you decide if the stock is worth further research. Interparfums has a price to earnings ratio of 40.99, based on the last twelve months. That means that at current prices, buyers pay €40.99 for every €1 in trailing yearly profits.

View our latest analysis for Interparfums

How Do I Calculate A Price To Earnings Ratio?

The formula for price to earnings is:

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

Or for Interparfums:

P/E of 40.99 = €42.85 ÷ €1.05 (Based on the year to December 2018.)

Is A High P/E Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each €1 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 Interparfums Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that Interparfums has a higher P/E than the average (17.6) P/E for companies in the personal products industry.

Interparfums's P/E tells us that market participants think the company will perform better than its industry peers, going forward. 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.

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 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.

Most would be impressed by Interparfums earnings growth of 19% in the last year. And it has bolstered its earnings per share by 4.4% per year over the last five years. So one might expect an above average P/E ratio.

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

Don't forget that the P/E ratio considers market capitalization. That means it doesn't take debt or cash into account. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).

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.

Is Debt Impacting Interparfums's P/E?

Interparfums has net cash of €183m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.

The Verdict On Interparfums's P/E Ratio

Interparfums trades on a P/E ratio of 41, which is above its market average of 17.6. 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 should be looking to buy stocks that the market is wrong about. 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 visual report on analyst forecasts could hold the key to an excellent investment decision.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

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.