This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll show how you can use ZAGG Inc’s (NASDAQ:ZAGG) P/E ratio to inform your assessment of the investment opportunity. ZAGG has a price to earnings ratio of 6.27, based on the last twelve months. In other words, at today’s prices, investors are paying $6.27 for every $1 in prior year profit.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for ZAGG:
P/E of 6.27 = $8.75 ÷ $1.4 (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 necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. 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.
In the last year, ZAGG grew EPS like Taylor Swift grew her fan base back in 2010; the 159% gain was both fast and well deserved. The sweetener is that the annual five year growth rate of 55% is also impressive. With that kind of growth rate we would generally expect a high P/E ratio.
How Does ZAGG’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that ZAGG has a lower P/E than the average (13.9) P/E for companies in the consumer durables industry.
Its relatively low P/E ratio indicates that ZAGG shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with ZAGG, it’s quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.
Remember: P/E Ratios Don’t Consider The Balance Sheet
The ‘Price’ in P/E reflects the market capitalization of the company. That means it doesn’t take debt or cash into account. 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.
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).
Is Debt Impacting ZAGG’s P/E?
ZAGG has net debt worth 17% of its market capitalization. It would probably deserve a higher P/E ratio if it was net cash, since it would have more options for growth.
The Verdict On ZAGG’s P/E Ratio
ZAGG has a P/E of 6.3. That’s below the average in the US market, which is 18.2. The EPS growth last year was strong, and debt levels are quite reasonable. If the company can continue to grow earnings, then the current P/E may be unjustifiably low. Since analysts are predicting growth will continue, one might expect to see a higher P/E so it may be worth looking closer.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
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 firstname.lastname@example.org. 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.