Why Garmin Ltd.'s (NASDAQ:GRMN) High P/E Ratio Isn't Necessarily A Bad Thing

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Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. To keep it practical, we'll show how Garmin Ltd.'s (NASDAQ:GRMN) P/E ratio could help you assess the value on offer. Garmin has a P/E ratio of 21.43, based on the last twelve months. That is equivalent to an earnings yield of about 4.7%.

View our latest analysis for Garmin

How Do You Calculate Garmin's P/E Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)

Or for Garmin:

P/E of 21.43 = $79.96 ÷ $3.73 (Based on the trailing twelve months to March 2019.)

Is A High P/E Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. When earnings grow, the 'E' increases, over time. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.

Most would be impressed by Garmin earnings growth of 17% in the last year. And earnings per share have improved by 2.5% annually, over the last five years. With that performance, you might expect an above average P/E ratio.

How Does Garmin'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 (13.8) for companies in the consumer durables industry is lower than Garmin's P/E.

Its relatively high P/E ratio indicates that Garmin shareholders think it will perform better than other companies in its industry classification. The market is optimistic about the future, but that doesn't guarantee future growth. So further research is always essential. I often monitor director buying and selling.

Remember: P/E Ratios Don't Consider The Balance Sheet

The 'Price' in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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 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.

Is Debt Impacting Garmin's P/E?

The extra options and safety that comes with Garmin's US$1.3b net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.

The Verdict On Garmin's P/E Ratio

Garmin trades on a P/E ratio of 21.4, which is above the US market average of 17.6. Its strong balance sheet gives the company plenty of resources for extra growth, and it has already proven it can grow. So it is not surprising the market is probably extrapolating recent growth well into the future, reflected in the relatively high P/E ratio.

Investors should be looking to buy stocks that the market is wrong about. 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.' 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 Garmin. 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 editorial-team@simplywallst.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.