This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we’ll show how MarketAxess Holdings Inc.’s (NASDAQ:MKTX) P/E ratio could help you assess the value on offer. MarketAxess Holdings has a P/E ratio of 76.5, based on the last twelve months. That is equivalent to an earnings yield of about 1.3%.
How Do I Calculate MarketAxess Holdings’s Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for MarketAxess Holdings:
P/E of 76.5 = $367.03 ÷ $4.8 (Based on the year to March 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each $1 of company earnings. 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 Does MarketAxess Holdings’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that MarketAxess Holdings has a higher P/E than the average (37.9) P/E for companies in the capital markets industry.
That means that the market expects MarketAxess Holdings will outperform other companies in its industry.
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. And in that case, the P/E ratio itself will drop rather quickly. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
It’s great to see that MarketAxess Holdings grew EPS by 15% in the last year. And its annual EPS growth rate over 5 years is 20%. This could arguably justify a relatively high P/E ratio.
Remember: P/E Ratios Don’t Consider The Balance Sheet
The ‘Price’ in P/E reflects the market capitalization of the company. 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.
MarketAxess Holdings’s Balance Sheet
The extra options and safety that comes with MarketAxess Holdings’s US$345m 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 MarketAxess Holdings’s P/E Ratio
MarketAxess Holdings’s P/E is 76.5 which suggests the market is more focussed on the future opportunity rather than the current level of earnings. Its net cash position supports a higher P/E ratio, as does its solid recent earnings growth. Therefore it seems reasonable that the market would have relatively high expectations of the company
Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
Of course you might be able to find a better stock than MarketAxess Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.
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. Thank you for reading.