Read This Before You Buy KB Home (NYSE:KBH) Because Of Its P/E Ratio

This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll show how you can use KB Home's (NYSE:KBH) P/E ratio to inform your assessment of the investment opportunity. What is KB Home's P/E ratio? Well, based on the last twelve months it is 12.24. That is equivalent to an earnings yield of about 8.2%.

View our latest analysis for KB Home

How Do You Calculate A P/E Ratio?

The formula for price to earnings is:

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

Or for KB Home:

P/E of 12.24 = $33.58 ÷ $2.74 (Based on the year to August 2019.)

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 is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.

Does KB Home Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio essentially measures market expectations of a company. You can see in the image below that the average P/E (12.7) for companies in the consumer durables industry is roughly the same as KB Home's P/E.

Its P/E ratio suggests that KB Home shareholders think that in the future it will perform about the same as other companies in its industry classification.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the 'E' will be higher. And in that case, the P/E ratio itself will drop rather quickly. Then, a lower P/E should attract more buyers, pushing the share price up.

In the last year, KB Home grew EPS like Taylor Swift grew her fan base back in 2010; the 53% gain was both fast and well deserved. The sweetener is that the annual five year growth rate of 21% is also impressive. So I'd be surprised if the P/E ratio was not above average. The market might therefore be 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

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. 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.

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.

How Does KB Home's Debt Impact Its P/E Ratio?

KB Home has net debt worth 56% of its market capitalization. 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 Verdict On KB Home's P/E Ratio

KB Home trades on a P/E ratio of 12.2, which is below the US market average of 18.3. While the EPS growth last year was strong, the significant debt levels reduce the number of options available to management. If it continues to grow, then the current low P/E may prove to be unjustified.

Investors should be looking to buy stocks that the market is wrong about. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

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 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.