Here's What Taro Pharmaceutical Industries Ltd.'s (NYSE:TARO) P/E Ratio Is Telling Us

This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll show how you can use Taro Pharmaceutical Industries Ltd.'s (NYSE:TARO) P/E ratio to inform your assessment of the investment opportunity. What is Taro Pharmaceutical Industries's P/E ratio? Well, based on the last twelve months it is 11.60. That is equivalent to an earnings yield of about 8.6%.

See our latest analysis for Taro Pharmaceutical Industries

How Do You Calculate A P/E Ratio?

The formula for P/E is:

Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)

Or for Taro Pharmaceutical Industries:

P/E of 11.60 = USD82.33 ÷ USD7.10 (Based on the year to September 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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 Does Taro Pharmaceutical Industries'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 Taro Pharmaceutical Industries has a lower P/E than the average (21.4) P/E for companies in the pharmaceuticals industry.

Taro Pharmaceutical Industries's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Taro Pharmaceutical Industries, it's quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.

How Growth Rates Impact P/E Ratios

If earnings fall then in the future the 'E' will be lower. That means unless the share price falls, the P/E will increase in a few years. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.

Taro Pharmaceutical Industries increased earnings per share by an impressive 20% over the last twelve months. But earnings per share are down 4.9% per year over the last five 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. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).

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).

Taro Pharmaceutical Industries's Balance Sheet

With net cash of US$1.1b, Taro Pharmaceutical Industries has a very strong balance sheet, which may be important for its business. Having said that, at 34% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.

The Bottom Line On Taro Pharmaceutical Industries's P/E Ratio

Taro Pharmaceutical Industries trades on a P/E ratio of 11.6, which is below the US market average of 18.4. The net cash position gives plenty of options to the business, and the recent improvement in EPS is good to see. The relatively low P/E ratio implies the market is pessimistic.

Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

But note: Taro Pharmaceutical Industries 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).

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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.

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. Thank you for reading.