The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll look at Masterflex SE’s (ETR:MZX) P/E ratio and reflect on what it tells us about the company’s share price. Masterflex has a P/E ratio of 13.88, based on the last twelve months. In other words, at today’s prices, investors are paying €13.88 for every €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 ÷ Earnings per Share (EPS)
Or for Masterflex:
P/E of 13.88 = €6.44 ÷ €0.46 (Based on the trailing twelve months to September 2018.)
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 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
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 even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.
Most would be impressed by Masterflex earnings growth of 16% in the last year. 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 Masterflex’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. The image below shows that Masterflex has a lower P/E than the average (15) P/E for companies in the machinery industry.
Masterflex’s P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Masterflex, it’s quite possible it could surprise on the upside. You 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 taking on debt (or spending its remaining cash).
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.
Masterflex’s Balance Sheet
Masterflex has net debt worth 37% of its market capitalization. If you want to compare its P/E ratio to other companies, you should absolutely keep in mind it has significant borrowings.
The Verdict On Masterflex’s P/E Ratio
Masterflex trades on a P/E ratio of 13.9, which is below the DE market average of 19.2. The EPS growth last year was strong, and debt levels are quite reasonable. If the company can continue to grow earnings, then the current P/E may be unjustifiably low.
Investors should be looking to buy stocks that the market is wrong about. 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 be able to find a better stock than Masterflex. So you may wish to see this free collection of other companies that have grown earnings strongly.
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