Should You Be Tempted To Sell Héroux-Devtek Inc. (TSE:HRX) Because Of Its P/E Ratio?

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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we’ll show how Héroux-Devtek Inc.’s (TSE:HRX) P/E ratio could help you assess the value on offer. What is Héroux-Devtek’s P/E ratio? Well, based on the last twelve months it is 28.43. That means that at current prices, buyers pay CA$28.43 for every CA$1 in trailing yearly profits.

See our latest analysis for Héroux-Devtek

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 Héroux-Devtek:

P/E of 28.43 = CA$15.75 ÷ CA$0.55 (Based on the trailing twelve months to December 2018.)

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. All else being equal, it’s better to pay a low price — but as Warren Buffett said, ‘It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.’

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. Earnings growth means that in the future the ‘E’ will be higher. 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.

Héroux-Devtek increased earnings per share by an impressive 20% over the last twelve months. And it has bolstered its earnings per share by 6.7% per year over the last five years. This could arguably justify a relatively high P/E ratio.

How Does Héroux-Devtek’s P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. As you can see below, Héroux-Devtek has a higher P/E than the average company (22.1) in the aerospace & defense industry.

TSX:HRX Price Estimation Relative to Market, May 2nd 2019
TSX:HRX Price Estimation Relative to Market, May 2nd 2019

That means that the market expects Héroux-Devtek will outperform other companies in its industry. 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.

Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits

The ‘Price’ in P/E reflects the market capitalization of the company. 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.

So What Does Héroux-Devtek’s Balance Sheet Tell Us?

Héroux-Devtek’s net debt equates to 45% of its market capitalization. While it’s worth keeping this in mind, it isn’t a worry.

The Verdict On Héroux-Devtek’s P/E Ratio

Héroux-Devtek has a P/E of 28.4. That’s higher than the average in the CA market, which is 15.1. Its debt levels do not imperil its balance sheet and it is growing EPS strongly. So on this analysis it seems reasonable that its P/E ratio is above average.

When the market is wrong about a stock, it gives savvy investors an opportunity. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

But note: Héroux-Devtek 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).

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 editorial-team@simplywallst.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. Thank you for reading.