This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll look at CRA International, Inc.’s (NASDAQ:CRAI) P/E ratio and reflect on what it tells us about the company’s share price. Based on the last twelve months, CRA International’s P/E ratio is 19.2. That means that at current prices, buyers pay $19.2 for every $1 in trailing yearly profits.
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 CRA International:
P/E of 19.2 = $53 ÷ $2.76 (Based on the year to December 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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
Probably the most important factor in determining what P/E a company trades on is the earnings growth. Earnings growth means that in the future the ‘E’ will be higher. That means even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
CRA International’s 200% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. The cherry on top is that the five year growth rate was an impressive 20% per year. So I’d be surprised if the P/E ratio was not above average.
How Does CRA International’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. The image below shows that CRA International has a lower P/E than the average (23.4) P/E for companies in the professional services industry.
Its relatively low P/E ratio indicates that CRA International shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. 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 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.
CRA International’s Balance Sheet
CRA International has net cash of US$38m. 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 CRA International’s P/E Ratio
CRA International trades on a P/E ratio of 19.2, which is fairly close to the US market average of 18.1. Its net cash position is the cherry on top of its superb EPS growth. So based on this analysis we’d expect CRA International to have a higher P/E ratio.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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 CRA International. 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).
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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.