Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at Hill-Rom Holdings, Inc.'s (NYSE:HRC) P/E ratio and reflect on what it tells us about the company's share price. Based on the last twelve months, Hill-Rom Holdings's P/E ratio is 33.48. That corresponds to an earnings yield of approximately 3.0%.
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 Hill-Rom Holdings:
P/E of 33.48 = $107.68 ÷ $3.22 (Based on the trailing twelve months to June 2019.)
Is A High P/E Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing 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.'
Does Hill-Rom Holdings Have A Relatively High Or Low P/E For Its Industry?
We can get an indication of market expectations by looking at the P/E ratio. If you look at the image below, you can see Hill-Rom Holdings has a lower P/E than the average (41) in the medical equipment industry classification.
Its relatively low P/E ratio indicates that Hill-Rom Holdings shareholders think it will struggle to do as well as other companies in its industry classification.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the 'E' increases, over time. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.
Hill-Rom Holdings saw earnings per share decrease by 8.3% last year. But EPS is up 21% over the last 5 years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The 'Price' in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.
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.
So What Does Hill-Rom Holdings's Balance Sheet Tell Us?
Hill-Rom Holdings's net debt equates to 26% of its market capitalization. While that's enough to warrant consideration, it doesn't really concern us.
The Bottom Line On Hill-Rom Holdings's P/E Ratio
Hill-Rom Holdings trades on a P/E ratio of 33.5, which is above its market average of 17.3. With a bit of debt, but a lack of recent growth, it's safe to say the market is expecting improved profit performance from the company, in the next few years.
Investors should be looking to buy stocks that the market is wrong about. 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 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.