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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll apply a basic P/E ratio analysis to Brady Corporation’s (NYSE:BRC), to help you decide if the stock is worth further research. Brady has a price to earnings ratio of 21.06, based on the last twelve months. That is equivalent to an earnings yield of about 4.7%.
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 Brady:
P/E of 21.06 = $48.53 ÷ $2.3 (Based on the year to January 2019.)
Is A High Price-to-Earnings Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing 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
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. 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.
Brady’s 54% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. Even better, EPS is up 115% per year over three years. So you might say it really deserves to have an above-average P/E ratio.
Does Brady Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio indicates whether the market has higher or lower expectations of a company. We can see in the image below that the average P/E (23.2) for companies in the commercial services industry is higher than Brady’s P/E.
Its relatively low P/E ratio indicates that Brady shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Brady, it’s quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
The ‘Price’ in P/E reflects the market capitalization of the company. So it won’t reflect the advantage of cash, or disadvantage of debt. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
How Does Brady’s Debt Impact Its P/E Ratio?
The extra options and safety that comes with Brady’s US$151m 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 Brady’s P/E Ratio
Brady’s P/E is 21.1 which is above average (18.1) in the US market. Its net cash position is the cherry on top of its superb EPS growth. So based on this analysis we’d expect Brady to have a high P/E ratio.
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 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 Brady. 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.