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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll look at Mastech Digital, Inc.’s (NYSEMKT:MHH) P/E ratio and reflect on what it tells us about the company’s share price. Mastech Digital has a P/E ratio of 11.21, based on the last twelve months. That is equivalent to an earnings yield of about 8.9%.
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Mastech Digital:
P/E of 11.21 = $6.85 ÷ $0.61 (Based on the year to December 2018.)
Is A High P/E 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
Earnings growth rates have a big influence on P/E ratios. Earnings growth means that in the future the ‘E’ will be higher. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
It’s nice to see that Mastech Digital grew EPS by a stonking 273% in the last year. And earnings per share have improved by 1.4% annually, over the last five years. With that performance, I would expect it to have an above average P/E ratio.
How Does Mastech Digital’s P/E Ratio Compare To Its Peers?
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 (26.4) for companies in the professional services industry is higher than Mastech Digital’s P/E.
This suggests that market participants think Mastech Digital will underperform other companies in its industry. Since the market seems unimpressed with Mastech Digital, 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.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don’t forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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).
How Does Mastech Digital’s Debt Impact Its P/E Ratio?
Net debt totals 50% of Mastech Digital’s market cap. This is a reasonably significant level of debt — all else being equal you’d expect a much lower P/E than if it had net cash.
The Bottom Line On Mastech Digital’s P/E Ratio
Mastech Digital has a P/E of 11.2. That’s below the average in the US market, which is 17.2. The EPS growth last year was strong, and debt levels are quite reasonable. If it continues to grow, then the current low P/E may prove to be unjustified.
When the market is wrong about a stock, it gives savvy investors an opportunity. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. We don’t have analyst forecasts, but you might want to assess this data-rich visualization of earnings, revenue and cash flow.
You might be able to find a better buy than Mastech Digital. 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. On rare occasion, data errors may occur. Thank you for reading.