This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll look at UDG Healthcare plc's (LON:UDG) P/E ratio and reflect on what it tells us about the company's share price. Based on the last twelve months, UDG Healthcare's P/E ratio is 49.36. That corresponds to an earnings yield of approximately 2.0%.
See our latest analysis for UDG Healthcare
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)
Or for UDG Healthcare:
P/E of 49.36 = $8.33 (Note: this is the share price in the reporting currency, namely, USD ) ÷ $0.17 (Based on the trailing twelve months to March 2018.)
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. 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
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. That means even if the current P/E is low, it will increase over time if the share price stays flat. Then, a higher P/E might scare off shareholders, pushing the share price down.
UDG Healthcare saw earnings per share decrease by 43% last year. And EPS is down 8.7% a year, over the last 3 years. This could justify a low P/E.
How Does UDG Healthcare's P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. You can see in the image below that the average P/E (27.2) for companies in the healthcare industry is lower than UDG Healthcare's P/E.
That means that the market expects UDG Healthcare will outperform other companies in its industry. 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. 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 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.
UDG Healthcare's Balance Sheet
UDG Healthcare has net debt worth just 2.2% of its market capitalization. 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 Bottom Line On UDG Healthcare's P/E Ratio
UDG Healthcare trades on a P/E ratio of 49.4, which is multiples above the GB market average of 16.1. With a bit of debt, but a lack of recent growth, it's safe to say the market is expecting improved profit performance from the company, in the next few years.
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 freereport 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 UDG Healthcare. So you may wish to see this freecollection of other companies that have grown earnings strongly.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.