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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll look at James Hardie Industries plc’s (ASX:JHX) P/E ratio and reflect on what it tells us about the company’s share price. James Hardie Industries has a P/E ratio of 25.51, based on the last twelve months. In other words, at today’s prices, investors are paying A$25.51 for every A$1 in prior year profit.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)
Or for James Hardie Industries:
P/E of 25.51 = $13.21 (Note: this is the share price in the reporting currency, namely, USD ) ÷ $0.52 (Based on the year to March 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
How Growth Rates Impact P/E Ratios
When earnings fall, the ‘E’ decreases, over time. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
In the last year, James Hardie Industries grew EPS like Taylor Swift grew her fan base back in 2010; the 56% gain was both fast and well deserved. The cherry on top is that the five year growth rate was an impressive 18% per year. With that kind of growth rate we would generally expect a high P/E ratio. On the other hand, the longer term performance is poor, with EPS down -18% per year over 3 years.
Does James Hardie Industries Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. As you can see below, James Hardie Industries has a higher P/E than the average company (14.6) in the basic materials industry.
James Hardie Industries’s P/E tells us that market participants think the company will perform better than its industry peers, going forward. 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.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
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).
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.
James Hardie Industries’s Balance Sheet
Net debt totals 22% of James Hardie Industries’s market cap. This could bring some additional risk, and reduce the number of investment options for management; worth remembering if you compare its P/E to businesses without debt.
The Bottom Line On James Hardie Industries’s P/E Ratio
James Hardie Industries’s P/E is 25.5 which is above average (16.2) in the AU market. Its debt levels do not imperil its balance sheet and its EPS growth is very healthy indeed. So to be frank we are not surprised it has a high P/E ratio.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
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.
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.