This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll look at Neogen Corporation’s (NASDAQ:NEOG) P/E ratio and reflect on what it tells us about the company’s share price. Based on the last twelve months, Neogen’s P/E ratio is 45.94. In other words, at today’s prices, investors are paying $45.94 for every $1 in prior year profit.
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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 Neogen:
P/E of 45.94 = $58.12 ÷ $1.27 (Based on the year to November 2018.)
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 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. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. That means even if the current P/E is high, it will reduce over time if the share price stays flat. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
It’s great to see that Neogen grew EPS by 24% in the last year. And it has bolstered its earnings per share by 17% per year over the last five years. This could arguably justify a relatively high P/E ratio.
How Does Neogen’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 (45.3) for companies in the medical equipment industry is roughly the same as Neogen’s P/E.
Neogen’s P/E tells us that market participants think its prospects are roughly in line with its industry. The company could surprise by performing better than average, in the future. I inform my view byby checking management tenure and remuneration, among other things.
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. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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.
Neogen’s Balance Sheet
Since Neogen holds net cash of US$241m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Bottom Line On Neogen’s P/E Ratio
Neogen trades on a P/E ratio of 45.9, which is above the US market average of 16.8. 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. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
But note: Neogen 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).
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 email@example.com.