Why Intuitive Surgical, Inc.'s (NASDAQ:ISRG) High P/E Ratio Isn't Necessarily A Bad Thing

The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to Intuitive Surgical, Inc.'s (NASDAQ:ISRG), to help you decide if the stock is worth further research. Based on the last twelve months, Intuitive Surgical's P/E ratio is 53.88. In other words, at today's prices, investors are paying $53.88 for every $1 in prior year profit.

View our latest analysis for Intuitive Surgical

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 53.88 = USD615.00 ÷ USD11.41 (Based on the year to September 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that buyers have to pay a higher price for each USD1 the company has earned over the last year. 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 Does Intuitive Surgical'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 Intuitive Surgical has a higher P/E than the average (47.6) P/E for companies in the medical equipment industry.

That means that the market expects Intuitive Surgical will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. 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.

Intuitive Surgical's 61% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. The cherry on top is that the five year growth rate was an impressive 24% per year. With that kind of growth rate we would generally expect a high P/E ratio.

Remember: P/E Ratios Don't Consider The Balance Sheet

Don't forget that the P/E ratio considers market capitalization. So it won't reflect the advantage of cash, or disadvantage of debt. 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?

Since Intuitive Surgical holds net cash of US$2.9b, it can spend on growth, justifying a higher P/E ratio than otherwise.

The Bottom Line On Intuitive Surgical's P/E Ratio

Intuitive Surgical's P/E is 53.9 which is above average (18.8) in its market. The excess cash it carries is the gravy on top its fast EPS growth. So based on this analysis we'd expect Intuitive Surgical to have a high P/E ratio.

When the market is wrong about a stock, it gives savvy investors an opportunity. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. 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.

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.

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. Thank you for reading.