Today, we’ll introduce the concept of the P/E ratio for those who are learning about investing. We’ll show how you can use Fisher & Paykel Healthcare Corporation Limited’s (NZSE:FPH) P/E ratio to inform your assessment of the investment opportunity. Fisher & Paykel Healthcare has a P/E ratio of 62.96, based on the last twelve months. That means that at current prices, buyers pay NZ$62.96 for every NZ$1 in trailing yearly profits.
How Do You Calculate Fisher & Paykel Healthcare’s P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Fisher & Paykel Healthcare:
P/E of 62.96 = NZ$25.570 ÷ NZ$0.406 (Based on the trailing twelve months to September 2019.)
(Note: the above calculation results may not be precise due to rounding.)
Is A High Price-to-Earnings Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. That isn’t a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business’s prospects, relative to stocks with a lower P/E.
Does Fisher & Paykel Healthcare 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 Fisher & Paykel Healthcare has a higher P/E than the average (33.1) P/E for companies in the medical equipment industry.
Fisher & Paykel Healthcare’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. If earnings are growing quickly, then the ‘E’ in the equation will increase faster than it would otherwise. And in that case, the P/E ratio itself will drop rather quickly. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Most would be impressed by Fisher & Paykel Healthcare earnings growth of 13% in the last year. And earnings per share have improved by 17% annually, over the last five years. So one might expect an above average P/E ratio.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The ‘Price’ in P/E reflects the market capitalization of the company. That means it doesn’t take debt or cash into account. 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.
Is Debt Impacting Fisher & Paykel Healthcare’s P/E?
Fisher & Paykel Healthcare’s net debt is 0.04% of its market cap. So it doesn’t have as many options as it would with net cash, but its debt would not have much of an impact on its P/E ratio.
The Bottom Line On Fisher & Paykel Healthcare’s P/E Ratio
Fisher & Paykel Healthcare’s P/E is 63.0 which suggests the market is more focussed on the future opportunity rather than the current level of earnings. The company is not overly constrained by its modest debt levels, and its recent EPS growth very solid. So on this analysis it seems reasonable that its P/E ratio is above average.
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 report on the analyst consensus forecasts could help you make a master move on this stock.
Of course you might be able to find a better stock than Fisher & Paykel Healthcare. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.
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