The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll look at Utah Medical Products, Inc.’s (NASDAQ:UTMD) P/E ratio and reflect on what it tells us about the company’s share price. Utah Medical Products has a price to earnings ratio of 17.59, based on the last twelve months. That corresponds to an earnings yield of approximately 5.7%.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Utah Medical Products:
P/E of 17.59 = $87.05 ÷ $4.95 (Based on the trailing twelve months to December 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each $1 the company has earned over the last year. 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. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. Then, a lower P/E should attract more buyers, pushing the share price up.
Utah Medical Products increased earnings per share by a whopping 116% last year. And it has bolstered its earnings per share by 2.3% per year over the last five years. I’d therefore be a little surprised if its P/E ratio was not relatively high.
How Does Utah Medical Products’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 Utah Medical Products has a lower P/E than the average (44.9) P/E for companies in the medical equipment industry.
This suggests that market participants think Utah Medical Products will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
The ‘Price’ in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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).
How Does Utah Medical Products’s Debt Impact Its P/E Ratio?
Utah Medical Products has net cash of US$51m. 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 Utah Medical Products’s P/E Ratio
Utah Medical Products has a P/E of 17.6. That’s around the same as the average in the US market, which is 17.6. The balance sheet is healthy, and recent EPS growth impressive, but the P/E implies some caution from the market.
Investors should be looking to buy stocks that the market is wrong about. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. We don’t have analyst forecasts, but you might want to assess this data-rich visualization of earnings, revenue and cash flow.
You might be able to find a better buy than Utah Medical Products. 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).
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.