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 Cutera, Inc.’s (NASDAQ:CUTR) P/E ratio could help you assess the value on offer. Cutera has a price to earnings ratio of 11.61, based on the last twelve months. In other words, at today’s prices, investors are paying $11.61 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 Cutera:
P/E of 11.61 = $15.57 ÷ $1.34 (Based on the trailing twelve months to September 2018.)
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 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
Earnings growth rates have a big influence on P/E ratios. When earnings grow, the ‘E’ increases, over time. 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.
Cutera increased earnings per share by a whopping 64% last year. And earnings per share have improved by 72% annually, over the last five years. So we’d generally expect it to have a relatively high P/E ratio.
How Does Cutera’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 Cutera has a lower P/E than the average (43.6) P/E for companies in the medical equipment industry.
Cutera’s P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Cutera, it’s quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
Remember: P/E Ratios Don’t Consider The Balance Sheet
Don’t forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. Theoretically, a business can improve its earnings (and produce a lower P/E in the future), by taking on debt (or spending its remaining cash).
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 Cutera’s P/E?
The extra options and safety that comes with Cutera’s US$27m 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 Cutera’s P/E Ratio
Cutera trades on a P/E ratio of 11.6, which is below the US market average of 15.6. It grew its EPS nicely over the last year, and the healthy balance sheet implies there is more potential for growth. The relatively low P/E ratio implies the market is pessimistic.
Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
You might be able to find a better buy than Cutera. 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).
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.