The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we’ll show how Moody’s Corporation’s (NYSE:MCO) P/E ratio could help you assess the value on offer. Based on the last twelve months, Moody’s’s P/E ratio is 34.17. That is equivalent to an earnings yield of about 2.9%.
How Do I Calculate Moody’s’s Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Moody’s:
P/E of 34.17 = $236.10 ÷ $6.91 (Based on the year to September 2019.)
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 is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
Does Moody’s 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 (34.2) for companies in the capital markets industry is roughly the same as Moody’s’s P/E.
Its P/E ratio suggests that Moody’s shareholders think that in the future it will perform about the same as other companies in its industry classification. The company could surprise by performing better than average, in the future. I would further inform my view by checking insider buying and selling., among other things.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. When earnings grow, the ‘E’ increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Moody’s increased earnings per share by an impressive 22% over the last twelve months. And earnings per share have improved by 8.9% annually, over the last five years. 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. 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.
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.
So What Does Moody’s’s Balance Sheet Tell Us?
Moody’s has net debt worth just 8.9% of its market capitalization. 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 Moody’s’s P/E Ratio
Moody’s has a P/E of 34.2. That’s higher than the average in its market, which is 18.7. 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 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 report on the analyst consensus forecasts could help you make a master move on this stock.
But note: Moody’s 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.
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