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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 Alpha Pro Tech, Ltd.’s (NYSEMKT:APT) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Alpha Pro Tech’s P/E ratio is 18.29. That is equivalent to an earnings yield of about 5.5%.
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 Alpha Pro Tech:
P/E of 18.29 = $4.12 ÷ $0.23 (Based on the trailing twelve months to September 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. 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. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Alpha Pro Tech’s earnings per share grew by -3.5% in the last twelve months. And it has bolstered its earnings per share by 15% per year over the last five years.
How Does Alpha Pro Tech’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 (17.6) for companies in the building industry is roughly the same as Alpha Pro Tech’s P/E.
Alpha Pro Tech’s P/E tells us that market participants think its prospects are roughly in line with its industry. So if Alpha Pro Tech actually outperforms its peers going forward, that should be a positive for the share price. Checking factors such as the tenure of the board and management could help you form your own view on if that will happen.
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. 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.
Alpha Pro Tech’s Balance Sheet
Alpha Pro Tech has net cash of US$7.1m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Verdict On Alpha Pro Tech’s P/E Ratio
Alpha Pro Tech’s P/E is 18.3 which is above average (16.8) in the US market. EPS was up modestly better over the last twelve months. And the healthy balance sheet means the company can sustain growth while the P/E suggests shareholders think it will.
Investors have an opportunity when market expectations about a stock are wrong. 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.’ Although we don’t have analyst forecasts, you might want to assess this data-rich visualization of earnings, revenue and cash flow.
But note: Alpha Pro Tech 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).
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 email@example.com.