This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll look at Heritage-Crystal Clean, Inc’s (NASDAQ:HCCI) P/E ratio and reflect on what it tells us about the company’s share price. Heritage-Crystal Clean has a price to earnings ratio of 44.93, based on the last twelve months. That is equivalent to an earnings yield of about 2.2%.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Heritage-Crystal Clean:
P/E of 44.93 = $26.06 ÷ $0.58 (Based on the trailing twelve months to June 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each $1 the company has earned over the last year. 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 Does Heritage-Crystal Clean’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Heritage-Crystal Clean has a higher P/E than the average (25.4) P/E for companies in the commercial services industry.
That means that the market expects Heritage-Crystal Clean will outperform other companies in its industry.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. And in that case, the P/E ratio itself will drop rather quickly. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
Heritage-Crystal Clean saw earnings per share decrease by 40% last year. But over the longer term (5 years) earnings per share have increased by 20%. The market might expect further growth, but it isn’t guaranteed. So further research is always essential. I often monitor director buying and selling.
Remember: P/E Ratios Don’t Consider The Balance Sheet
Don’t forget that the P/E ratio considers market capitalization. In other words, it does not consider any debt or cash that the company may have on the balance sheet. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
While growth expenditure doesn’t always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
Is Debt Impacting Heritage-Crystal Clean’s P/E?
The extra options and safety that comes with Heritage-Crystal Clean’s US$23m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Bottom Line On Heritage-Crystal Clean’s P/E Ratio
Heritage-Crystal Clean has a P/E of 44.9. That’s higher than the average in its market, which is 17.9. The recent drop in earnings per share might keep value investors away, but the relatively strong balance sheet will allow the company time to invest in growth. Clearly, the high P/E indicates shareholders think it will!
Investors should be looking to buy stocks that the market is wrong about. 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 visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
You might be able to find a better buy than Heritage-Crystal Clean. 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).
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.