The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we’ll show how HD Supply Holdings, Inc.’s (NASDAQ:HDS) P/E ratio could help you assess the value on offer. HD Supply Holdings has a price to earnings ratio of 24.55, based on the last twelve months. That corresponds to an earnings yield of approximately 4.1%.
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How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for HD Supply Holdings:
P/E of 24.55 = $37.81 ÷ $1.54 (Based on the trailing twelve months to October 2018.)
Is A High P/E Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each $1 of company earnings. That isn’t a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business’s prospects, relative to stocks with a lower P/E.
How Growth Rates Impact P/E Ratios
When earnings fall, the ‘E’ decreases, over time. That means unless the share price falls, the P/E will increase in a few years. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
It’s nice to see that HD Supply Holdings grew EPS by a stonking 43% in the last year. And earnings per share have improved by 33% annually, over the last five years. So we’d generally expect it to have a relatively high P/E ratio. Unfortunately, earnings per share are down 55% a year, over 3 years.
How Does HD Supply Holdings’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 (11.9) for companies in the trade distributors industry is lower than HD Supply Holdings’s P/E.
HD Supply Holdings’s P/E tells us that market participants think the company will perform better than its industry peers, going forward. Shareholders are clearly optimistic, but the future is always uncertain. So further research is always essential. I often monitor director buying and selling.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don’t forget that the P/E ratio considers market capitalization. That means it doesn’t take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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 HD Supply Holdings’s P/E?
HD Supply Holdings’s net debt is 29% of its market cap. This is enough debt that you’d have to make some adjustments before using the P/E ratio to compare it to a company with net cash.
The Verdict On HD Supply Holdings’s P/E Ratio
HD Supply Holdings’s P/E is 24.5 which is above average (16.8) in the US market. The company is not overly constrained by its modest debt levels, and it is growing earnings per share. So it is not surprising the market is probably extrapolating recent growth well into the future, reflected in the relatively high P/E ratio.
Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
You might be able to find a better buy than HD Supply Holdings. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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 firstname.lastname@example.org.