This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll look at Parker-Hannifin Corporation’s (NYSE:PH) P/E ratio and reflect on what it tells us about the company’s share price. Based on the last twelve months, Parker-Hannifin’s P/E ratio is 16.12. That corresponds to an earnings yield of approximately 6.2%.
How Do You Calculate Parker-Hannifin’s P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Parker-Hannifin:
P/E of 16.12 = $171.62 ÷ $10.65 (Based on the trailing twelve months to December 2018.)
Is A High Price-to-Earnings 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
P/E ratios primarily reflect market expectations around earnings growth rates. 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.
It’s nice to see that Parker-Hannifin grew EPS by a stonking 62% in the last year. And earnings per share have improved by 4.7% annually, over the last five years. With that performance, I would expect it to have an above average P/E ratio.
How Does Parker-Hannifin’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. We can see in the image below that the average P/E (20.8) for companies in the machinery industry is higher than Parker-Hannifin’s P/E.
Its relatively low P/E ratio indicates that Parker-Hannifin shareholders think it will struggle to do as well as other companies in its industry classification. Many investors like to buy stocks when the market is pessimistic about their prospects. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
Remember: P/E Ratios Don’t Consider The Balance Sheet
The ‘Price’ in P/E reflects the market capitalization of the company. That means it doesn’t take debt or cash into account. 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).
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).
Parker-Hannifin’s Balance Sheet
Parker-Hannifin’s net debt is 20% of its market cap. It would probably deserve a higher P/E ratio if it was net cash, since it would have more options for growth.
The Bottom Line On Parker-Hannifin’s P/E Ratio
Parker-Hannifin has a P/E of 16.1. That’s below the average in the US market, which is 17.7. The company does have a little debt, and EPS growth was good last year. If the company can continue to grow earnings, then the current P/E may be unjustifiably low. Since analysts are predicting growth will continue, one might expect to see a higher P/E so it may be worth looking closer.
Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E 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 email@example.com. 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.