Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. To keep it practical, we'll show how TOTAL S.A.'s (EPA:FP) P/E ratio could help you assess the value on offer. Looking at earnings over the last twelve months, TOTAL has a P/E ratio of 13.91. That is equivalent to an earnings yield of about 7.2%.
See our latest analysis for TOTAL
How Do I Calculate TOTAL's Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)
Or for TOTAL:
P/E of 13.91 = €51.87 (Note: this is the share price in the reporting currency, namely, USD ) ÷ €3.73 (Based on the year to September 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each €1 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.
Does TOTAL 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. The image below shows that TOTAL has a lower P/E than the average (16.1) P/E for companies in the oil and gas industry.
This suggests that market participants think TOTAL will underperform other companies in its industry. Since the market seems unimpressed with TOTAL, it's quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the 'E' will be higher. 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.
TOTAL shrunk earnings per share by 15% over the last year. But it has grown its earnings per share by 30% per year over the last three years. And EPS is down 7.0% a year, over the last 5 years. This growth rate might warrant a below average P/E ratio.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don't forget that the P/E ratio considers market capitalization. So it won't reflect the advantage of cash, or disadvantage of debt. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.
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.
How Does TOTAL's Debt Impact Its P/E Ratio?
Net debt totals 22% of TOTAL's market cap. This could bring some additional risk, and reduce the number of investment options for management; worth remembering if you compare its P/E to businesses without debt.
The Bottom Line On TOTAL's P/E Ratio
TOTAL's P/E is 13.9 which is below average (17.9) in the FR market. With only modest debt, it's likely the lack of EPS growth at least partially explains the pessimism implied by the P/E ratio.
When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
But note: TOTAL 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).
If you spot an error that warrants correction, please contact the editor at email@example.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.
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