This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll show how you can use LifeVantage Corporation’s (NASDAQ:LFVN) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, LifeVantage’s P/E ratio is 31.86. That means that at current prices, buyers pay $31.86 for every $1 in trailing yearly profits.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for LifeVantage:
P/E of 31.86 = $14.48 ÷ $0.45 (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
Probably the most important factor in determining what P/E a company trades on is the earnings growth. Earnings growth means that in the future the ‘E’ will be higher. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
Notably, LifeVantage grew EPS by a whopping 396% in the last year. And its annual EPS growth rate over 3 years is 2.1%. I’d therefore be a little surprised if its P/E ratio was not relatively high. In contrast, EPS has decreased by 23%, annually, over 5 years.
How Does LifeVantage’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 LifeVantage has a higher P/E than the average (24.5) P/E for companies in the personal products industry.
That means that the market expects LifeVantage will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. So further research is always essential. I often monitor director buying and selling.
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. 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 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.
Is Debt Impacting LifeVantage’s P/E?
Since LifeVantage holds net cash of US$15m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Verdict On LifeVantage’s P/E Ratio
LifeVantage has a P/E of 31.9. That’s higher than the average in the US market, which is 17.7. Its strong balance sheet gives the company plenty of resources for extra growth, and it has already proven it can grow. So it does not seem strange that the P/E is above average.
Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. 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 LifeVantage. 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.