Should You Be Tempted To Sell Columbus McKinnon Corporation (NASDAQ:CMCO) Because Of Its P/E Ratio?

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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll look at Columbus McKinnon Corporation's (NASDAQ:CMCO) P/E ratio and reflect on what it tells us about the company's share price. Columbus McKinnon has a P/E ratio of 25.87, based on the last twelve months. In other words, at today's prices, investors are paying $25.87 for every $1 in prior year profit.

Check out our latest analysis for Columbus McKinnon

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 Columbus McKinnon:

P/E of 25.87 = $34.92 ÷ $1.35 (Based on the year to December 2018.)

Is A High P/E 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. 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. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.

It's nice to see that Columbus McKinnon grew EPS by a stonking 243% in the last year. And its annual EPS growth rate over 3 years is 2.1%. I'd therefore be a little surprised if its P/E ratio was not relatively high. In contrast, EPS has decreased by 23%, annually, over 5 years.

How Does Columbus McKinnon's P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. You can see in the image below that the average P/E (19.5) for companies in the machinery industry is lower than Columbus McKinnon's P/E.

Columbus McKinnon'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 always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

Remember: P/E Ratios Don't Consider The Balance Sheet

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. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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.

How Does Columbus McKinnon's Debt Impact Its P/E Ratio?

Columbus McKinnon's net debt is 34% of its market cap. This is a reasonably significant level of debt -- all else being equal you'd expect a much lower P/E than if it had net cash.

The Bottom Line On Columbus McKinnon's P/E Ratio

Columbus McKinnon's P/E is 25.9 which is above average (16.8) in the US market. While the company does use modest debt, its recent earnings growth is impressive. So it is not surprising the market is probably extrapolating recent growth well into the future, reflected in the relatively 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 freevisual report on analyst forecasts could hold they key to an excellent investment decision.

Of course you might be able to find a better stock than Columbus McKinnon. 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.