This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we’ll show how PetMed Express, Inc.’s (NASDAQ:PETS) P/E ratio could help you assess the value on offer. What is PetMed Express’s P/E ratio? Well, based on the last twelve months it is 22.28. That means that at current prices, buyers pay $22.28 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 PetMed Express:
P/E of 22.28 = USD28.14 ÷ USD1.26 (Based on the trailing twelve months to December 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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 PetMed Express Have A Relatively High Or Low P/E For Its Industry?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that PetMed Express has a lower P/E than the average (29.9) P/E for companies in the online retail industry.
Its relatively low P/E ratio indicates that PetMed Express shareholders think it will struggle to do as well as other companies in its industry classification. Many investors like to buy stocks when the market is pessimistic about their prospects. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company’s P/E multiple. Earnings growth means that in the future the ‘E’ will be higher. 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.
PetMed Express saw earnings per share decrease by 38% last year. But EPS is up 8.2% over the last 5 years.
Remember: P/E Ratios Don’t Consider The Balance Sheet
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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 investing in growth. That means taking on debt (or spending its 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.
PetMed Express’s Balance Sheet
With net cash of US$92m, PetMed Express has a very strong balance sheet, which may be important for its business. Having said that, at 16% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Bottom Line On PetMed Express’s P/E Ratio
PetMed Express has a P/E of 22.3. That’s higher than the average in its market, which is 18.3. The recent drop in earnings per share might keep value investors away, but the net cash position means the company has time to improve: and the high P/E suggests the market thinks it will.
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 visual report on analyst forecasts could hold the key to an excellent investment decision.
But note: PetMed Express may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio 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.
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.