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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll show how you can use ASML Holding N.V.’s (AMS:ASML) P/E ratio to inform your assessment of the investment opportunity. ASML Holding has a price to earnings ratio of 26.27, based on the last twelve months. That corresponds to an earnings yield of approximately 3.8%.

See our latest analysis for ASML Holding

How Do You Calculate ASML Holding’s P/E Ratio?

The formula for price to earnings is:

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

Or for ASML Holding:

P/E of 26.27 = €160.2 ÷ €6.1 (Based on the year to December 2018.)

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.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. That means even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.

ASML Holding increased earnings per share by a whopping 27% last year. And it has bolstered its earnings per share by 14% per year over the last five years. So we’d generally expect it to have a relatively high P/E ratio.

How Does ASML Holding’s P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. The image below shows that ASML Holding has a higher P/E than the average (16.4) P/E for companies in the semiconductor industry.

That means that the market expects ASML Holding will outperform other companies in its industry. 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.

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

Don’t forget that the P/E ratio considers market capitalization. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Theoretically, a business can improve its earnings (and produce a lower P/E in the future), by taking on debt (or spending its remaining cash).

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.

How Does ASML Holding’s Debt Impact Its P/E Ratio?

ASML Holding has net cash of €865m. 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 ASML Holding’s P/E Ratio

ASML Holding’s P/E is 26.3 which is above average (16.1) in the NL market. With cash in the bank the company has plenty of growth options — and it is already on the right track. So it is not surprising the market is probably extrapolating recent growth well into the future, reflected in the relatively high P/E ratio.

Investors have an opportunity when market expectations about a stock are wrong. 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 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.