This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll look at National Instruments Corporation’s (NASDAQ:NATI) P/E ratio and reflect on what it tells us about the company’s share price. National Instruments has a P/E ratio of 32.40, based on the last twelve months. That means that at current prices, buyers pay $32.40 for every $1 in trailing yearly profits.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for National Instruments:
P/E of 32.40 = $39.880 ÷ $1.231 (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 buyers have to pay a higher price for each $1 the company has earned over the last year. 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.
How Does National Instruments’s P/E Ratio Compare To Its Peers?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. You can see in the image below that the average P/E (17.5) for companies in the electronic industry is lower than National Instruments’s P/E.
That means that the market expects National Instruments will outperform other companies in its industry. The market is optimistic about the future, but that doesn’t guarantee future growth. 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. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. 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.
National Instruments’s earnings per share grew by -4.8% in the last twelve months. And its annual EPS growth rate over 5 years is 4.4%.
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. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
While growth expenditure doesn’t always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
National Instruments’s Balance Sheet
Since National Instruments holds net cash of US$433m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Bottom Line On National Instruments’s P/E Ratio
National Instruments trades on a P/E ratio of 32.4, which is above its market average of 16.2. EPS was up modestly better over the last twelve months. And the net cash position provides the company with multiple options. The high P/E suggests the market thinks further growth will come.
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.
Of course you might be able to find a better stock than National Instruments. 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 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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