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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 Toromont Industries Ltd.’s (TSE:TIH) P/E ratio and reflect on what it tells us about the company’s share price. Toromont Industries has a price to earnings ratio of 18.89, based on the last twelve months. That is equivalent to an earnings yield of about 5.3%.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Toromont Industries:
P/E of 18.89 = CA$60.5 ÷ CA$3.2 (Based on the year to March 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each CA$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
P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the ‘E’ increases, over time. That means even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
Notably, Toromont Industries grew EPS by a whopping 42% in the last year. And earnings per share have improved by 15% annually, over the last five years. With that performance, I would expect it to have an above average P/E ratio.
Does Toromont 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, Toromont Industries has a higher P/E than the average company (13.2) in the trade distributors industry.
Toromont 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 further research is always essential. I often monitor director buying and selling.
Remember: P/E Ratios Don’t Consider The Balance Sheet
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. 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.
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.
Is Debt Impacting Toromont Industries’s P/E?
Net debt totals just 9.3% of Toromont Industries’s market cap. It would probably trade on a higher P/E ratio if it had a lot of cash, but I doubt it is having a big impact.
The Bottom Line On Toromont Industries’s P/E Ratio
Toromont Industries trades on a P/E ratio of 18.9, which is above the CA market average of 15. The company is not overly constrained by its modest debt levels, and its recent EPS growth is nothing short of stand-out. So on this analysis a high P/E ratio seems reasonable.
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 visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
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 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. Thank you for reading.