The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll look at GATX Corporation’s (NYSE:GATX) P/E ratio and reflect on what it tells us about the company’s share price. GATX has a price to earnings ratio of 13.16, based on the last twelve months. That is equivalent to an earnings yield of about 7.6%.
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 GATX:
P/E of 13.16 = USD77.85 ÷ USD5.92 (Based on the trailing twelve months to December 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each USD1 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.
Does GATX Have A Relatively High Or Low P/E For Its Industry?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. The image below shows that GATX has a lower P/E than the average (17.6) P/E for companies in the trade distributors industry.
Its relatively low P/E ratio indicates that GATX shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with GATX, 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
If earnings fall then in the future the ‘E’ will be lower. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. Then, a higher P/E might scare off shareholders, pushing the share price down.
GATX’s earnings per share grew by -5.3% in the last twelve months. And it has bolstered its earnings per share by 5.4% per year over the last five years. Unfortunately, earnings per share are down 2.3% a year, over 3 years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
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. 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.
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
GATX’s Balance Sheet
GATX has net debt worth a very significant 170% of its market capitalization. If you want to compare its P/E ratio to other companies, you must keep in mind that these debt levels would usually warrant a relatively low P/E.
The Verdict On GATX’s P/E Ratio
GATX’s P/E is 13.2 which is below average (18.6) in the US market. It’s good to see EPS growth in the last 12 months, but the debt on the balance sheet might be muting expectations.
When the market is wrong about a stock, it gives savvy investors an opportunity. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. 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.
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.
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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