The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll look at Axalta Coating Systems Ltd.’s (NYSE:AXTA) P/E ratio and reflect on what it tells us about the company’s share price. Axalta Coating Systems has a price to earnings ratio of 23.43, based on the last twelve months. In other words, at today’s prices, investors are paying $23.43 for every $1 in prior year profit.

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 Axalta Coating Systems:

P/E of 23.43 = USD28.26 ÷ USD1.21 (Based on the year to September 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each USD1 of company earnings. 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 Axalta Coating Systems Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio essentially measures market expectations of a company. The image below shows that Axalta Coating Systems has a higher P/E than the average (20.2) P/E for companies in the chemicals industry.

That means that the market expects Axalta Coating Systems will outperform other companies in its industry. Clearly the market expects growth, but it isn’t guaranteed. So further research is always essential. I often monitor director buying and selling.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. 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.

Axalta Coating Systems’s earnings made like a rocket, taking off 312% last year. And earnings per share have improved by 36% annually, over the last three years. So you might say it really deserves to have an above-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. Thus, the metric does not reflect cash or debt held by the company. 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).

While growth expenditure doesn’t always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.

How Does Axalta Coating Systems’s Debt Impact Its P/E Ratio?

Net debt is 46% of Axalta Coating Systems’s market cap. While that’s enough to warrant consideration, it doesn’t really concern us.

The Verdict On Axalta Coating Systems’s P/E Ratio

Axalta Coating Systems’s P/E is 23.4 which is above average (18.3) in its market. The company is not overly constrained by its modest debt levels, and its recent EPS growth is nothing short of stand-out. So on this analysis a high P/E ratio seems reasonable.

When the market is wrong about a stock, it gives savvy investors an opportunity. 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.