This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll show how you can use The Toro Company’s (NYSE:TTC) P/E ratio to inform your assessment of the investment opportunity. What is Toro’s P/E ratio? Well, based on the last twelve months it is 24.57. That corresponds to an earnings yield of approximately 4.1%.
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 Toro:
P/E of 24.57 = $71.51 ÷ $2.91 (Based on the year to February 2019.)
Is A High P/E 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 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. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
It’s nice to see that Toro grew EPS by a stonking 28% in the last year. And earnings per share have improved by 18% annually, over the last five years. I’d therefore be a little surprised if its P/E ratio was not relatively high.
Does Toro 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. You can see in the image below that the average P/E (21.1) for companies in the machinery industry is lower than Toro’s P/E.
Its relatively high P/E ratio indicates that Toro shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn’t guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. 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).
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).
Is Debt Impacting Toro’s P/E?
Net debt totals just 0.8% of Toro’s market cap. The market might award it a higher P/E ratio if it had net cash, but its unlikely this low level of net borrowing is having a big impact on the P/E multiple.
The Verdict On Toro’s P/E Ratio
Toro’s P/E is 24.6 which is above average (18.1) in the US market. Its debt levels do not imperil its balance sheet and it is growing EPS strongly. Therefore, it’s not particularly surprising that it has a above average P/E ratio.
Investors have an opportunity when market expectations about a stock are wrong. 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 Toro. So you may wish to see this free collection of other companies that have grown earnings strongly.
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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. Thank you for reading.