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 Allied Motion Technologies Inc.’s (NASDAQ:AMOT), to help you decide if the stock is worth further research. Allied Motion Technologies has a price to earnings ratio of 26.10, based on the last twelve months. That corresponds to an earnings yield of approximately 3.8%.
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Allied Motion Technologies:
P/E of 26.10 = USD45.04 ÷ USD1.73 (Based on the trailing twelve months 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 USD1 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 Allied Motion Technologies Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. You can see in the image below that the average P/E (20.6) for companies in the electrical industry is lower than Allied Motion Technologies’s P/E.
Allied Motion Technologies’s P/E tells us that market participants think the company will perform better than its industry peers, going forward. Shareholders are clearly optimistic, but the future is always uncertain. 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. Earnings growth means that in the future the ‘E’ will be higher. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. Then, a lower P/E should attract more buyers, pushing the share price up.
Allied Motion Technologies increased earnings per share by an impressive 19% over the last twelve months. And it has bolstered its earnings per share by 8.8% per year over the last five years. This could arguably justify a relatively high P/E ratio.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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 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 Allied Motion Technologies’s Debt Impact Its P/E Ratio?
Allied Motion Technologies has net debt equal to 25% of its market cap. While that’s enough to warrant consideration, it doesn’t really concern us.
The Verdict On Allied Motion Technologies’s P/E Ratio
Allied Motion Technologies trades on a P/E ratio of 26.1, which is above its market average of 18.4. While the company does use modest debt, its recent earnings growth is very good. Therefore, it’s not particularly surprising that it has a above average P/E ratio.
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. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
You might be able to find a better buy than Allied Motion Technologies. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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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