The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll look at MAXIMUS, Inc.’s (NYSE:MMS) P/E ratio and reflect on what it tells us about the company’s share price. MAXIMUS has a P/E ratio of 13.97, based on the last twelve months. That means that at current prices, buyers pay $13.97 for every $1 in trailing yearly profits.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for MAXIMUS:
P/E of 13.97 = $52.820 ÷ $3.781 (Based on the trailing twelve months to December 2019.)
(Note: the above calculation results may not be precise due to rounding.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each $1 of company earnings. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
How Does MAXIMUS’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. We can see in the image below that the average P/E (24.5) for companies in the it industry is higher than MAXIMUS’s P/E.
Its relatively low P/E ratio indicates that MAXIMUS shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with MAXIMUS, 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. If earnings are growing quickly, then the ‘E’ in the equation will increase faster than it would otherwise. 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.
MAXIMUS increased earnings per share by an impressive 13% over the last twelve months. And its annual EPS growth rate over 5 years is 11%. This could arguably justify a relatively high 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. 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 MAXIMUS’s Debt Impact Its P/E Ratio?
Since MAXIMUS holds net cash of US$143m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Verdict On MAXIMUS’s P/E Ratio
MAXIMUS’s P/E is 14.0 which is about average (13.3) in the US market. With a strong balance sheet combined with recent growth, the P/E implies the market is quite pessimistic.
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 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 MAXIMUS. 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 firstname.lastname@example.org. 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.
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. Thank you for reading.