The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we’ll show how La-Z-Boy Incorporated’s (NYSE:LZB) P/E ratio could help you assess the value on offer. La-Z-Boy has a price to earnings ratio of 15.16, based on the last twelve months. That is equivalent to an earnings yield of about 6.6%.
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 La-Z-Boy:
P/E of 15.16 = $32.64 ÷ $2.15 (Based on the year to January 2019.)
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 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
P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the ‘E’ will be higher. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
It’s nice to see that La-Z-Boy grew EPS by a stonking 39% in the last year. And it has bolstered its earnings per share by 11% per year over the last five years. With that performance, I would expect it to have an above average P/E ratio.
How Does La-Z-Boy’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 (12) for companies in the consumer durables industry is lower than La-Z-Boy’s P/E.
La-Z-Boy’s P/E tells us that market participants think the company will perform better than its industry peers, going forward. Clearly the market expects growth, but it isn’t guaranteed. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don’t forget that the P/E ratio considers market capitalization. That means it doesn’t take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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 La-Z-Boy’s Debt Impact Its P/E Ratio?
The extra options and safety that comes with La-Z-Boy’s US$99m 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 La-Z-Boy’s P/E Ratio
La-Z-Boy has a P/E of 15.2. That’s below the average in the US market, which is 17.5. Not only should the net cash position reduce risk, but the recent growth has been impressive. One might conclude that the market is a bit pessimistic, given the low P/E ratio.
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. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
But note: La-Z-Boy may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio 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.