Should You Be Tempted To Sell Intuitive Surgical, Inc. (NASDAQ:ISRG) 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). To keep it practical, we’ll show how Intuitive Surgical, Inc.’s (NASDAQ:ISRG) P/E ratio could help you assess the value on offer. What is Intuitive Surgical’s P/E ratio? Well, based on the last twelve months it is 48.83. That is equivalent to an earnings yield of about 2.0%.

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How Do You Calculate Intuitive Surgical’s P/E Ratio?

The formula for P/E is:

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

Or for Intuitive Surgical:

P/E of 48.83 = $490.14 ÷ $10.04 (Based on the trailing twelve months to March 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.

How Growth Rates Impact P/E Ratios

Probably the most important factor in determining what P/E a company trades on is the earnings growth. When earnings grow, the ‘E’ increases, over time. That means unless the share price increases, the P/E will reduce in a few years. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

It’s nice to see that Intuitive Surgical grew EPS by a stonking 44% in the last year. And its annual EPS growth rate over 5 years is 17%. With that performance, I would expect it to have an above average P/E ratio.

Does Intuitive Surgical 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 (38.8) for companies in the medical equipment industry is lower than Intuitive Surgical’s P/E.

NasdaqGS:ISRG Price Estimation Relative to Market, May 20th 2019
NasdaqGS:ISRG Price Estimation Relative to Market, May 20th 2019

Intuitive Surgical’s P/E tells us that market participants think the company will perform better than its industry peers, going forward. The market is optimistic about the future, but that doesn’t guarantee future growth. So investors should delve deeper. I like to check if company insiders have been buying or selling.

Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits

Don’t forget that the P/E ratio considers market capitalization. That means it doesn’t take debt or cash into account. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).

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 Intuitive Surgical’s P/E?

Intuitive Surgical has net cash of US$2.7b. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.

The Verdict On Intuitive Surgical’s P/E Ratio

Intuitive Surgical’s P/E is 48.8 which is above average (17.7) in the US market. Its net cash position is the cherry on top of its superb EPS growth. To us, this is the sort of company that we would expect to carry an above average price tag (relative to earnings).

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 report on the analyst consensus forecasts could help you make a master move on this stock.

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.