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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 show how you can use MSC Industrial Direct Co., Inc.’s (NYSE:MSM) P/E ratio to inform your assessment of the investment opportunity. MSC Industrial Direct has a price to earnings ratio of 15.49, based on the last twelve months. That is equivalent to an earnings yield of about 6.5%.
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for MSC Industrial Direct:
P/E of 15.49 = $81.74 ÷ $5.28 (Based on the trailing twelve months to March 2019.)
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
Generally speaking the rate of earnings growth has a profound impact on a company’s P/E multiple. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. That means unless the share price increases, the P/E will reduce in a few years. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
MSC Industrial Direct had pretty flat EPS growth in the last year. But over the longer term (5 years) earnings per share have increased by 7.9%.
How Does MSC Industrial Direct’s P/E Ratio Compare To Its Peers?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. As you can see below MSC Industrial Direct has a P/E ratio that is fairly close for the average for the trade distributors industry, which is 16.4.
MSC Industrial Direct’s P/E tells us that market participants think its prospects are roughly in line with its industry. So if MSC Industrial Direct actually outperforms its peers going forward, that should be a positive for the share price. I inform my view byby checking management tenure and remuneration, among other things.
Remember: P/E Ratios Don’t Consider The Balance Sheet
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. Thus, the metric does not reflect cash or debt held by the company. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
So What Does MSC Industrial Direct’s Balance Sheet Tell Us?
MSC Industrial Direct has net debt worth 12% of its market capitalization. That’s enough debt to impact the P/E ratio a little; so keep it in mind if you’re comparing it to companies without debt.
The Bottom Line On MSC Industrial Direct’s P/E Ratio
MSC Industrial Direct trades on a P/E ratio of 15.5, which is below the US market average of 18.1. The debt levels are not a major concern, but the lack of EPS growth is likely weighing on sentiment.
Investors have an opportunity when market expectations about a stock are wrong. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. 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.
But note: MSC Industrial Direct may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio 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 firstname.lastname@example.org. 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.