The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we’ll show how AmerisourceBergen Corporation’s (NYSE:ABC) P/E ratio could help you assess the value on offer. AmerisourceBergen has a price to earnings ratio of 14.73, based on the last twelve months. In other words, at today’s prices, investors are paying $14.73 for every $1 in prior year profit.
How Do You Calculate AmerisourceBergen’s P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for AmerisourceBergen:
P/E of 14.73 = $81.07 ÷ $5.5 (Based on the year to December 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. All else being equal, it’s better to pay a low price — but as Warren Buffett said, ‘It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.’
How Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the ‘E’ in the equation. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. A higher P/E should indicate the stock is expensive relative to others — and that may encourage shareholders to sell.
Most would be impressed by AmerisourceBergen earnings growth of 23% in the last year. And its annual EPS growth rate over 5 years is 34%. This could arguably justify a relatively high P/E ratio. Unfortunately, earnings per share are down 1.1% a year, over 3 years.
How Does AmerisourceBergen’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 AmerisourceBergen has a lower P/E than the average (21.2) P/E for companies in the healthcare industry.
Its relatively low P/E ratio indicates that AmerisourceBergen shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
AmerisourceBergen’s Balance Sheet
AmerisourceBergen has net debt worth 12% of its market capitalization. That’s enough debt to impact the P/E ratio a little; so keep it in mind if you’re comparing it to companies without debt.
The Bottom Line On AmerisourceBergen’s P/E Ratio
AmerisourceBergen’s P/E is 14.7 which is below average (17.7) in the US market. The company does have a little debt, and EPS growth was good last year. The low P/E ratio suggests current market expectations are muted, implying these levels of growth will not continue.
When the market is wrong about a stock, it gives savvy investors an opportunity. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
Of course you might be able to find a better stock than AmerisourceBergen. So you may wish to see this free collection of other companies that have grown earnings strongly.
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 firstname.lastname@example.org. 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.