Despite Its High P/E Ratio, Is Tractor Supply Company (NASDAQ:TSCO) Still Undervalued?

This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll look at Tractor Supply Company's (NASDAQ:TSCO) P/E ratio and reflect on what it tells us about the company's share price. Looking at earnings over the last twelve months, Tractor Supply has a P/E ratio of 23.75. In other words, at today's prices, investors are paying $23.75 for every $1 in prior year profit.

See our latest analysis for Tractor Supply

How Do You Calculate Tractor Supply's P/E Ratio?

The formula for price to earnings is:

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

Or for Tractor Supply:

P/E of 23.75 = $103.09 ÷ $4.34 (Based on the trailing twelve months to December 2018.)

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. That isn't necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. When earnings grow, the 'E' increases, over time. That means unless the share price increases, the P/E will reduce in a few years. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Tractor Supply increased earnings per share by a whopping 31% last year. And it has bolstered its earnings per share by 13% 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 Tractor Supply's P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. You can see in the image below that the average P/E (16.7) for companies in the specialty retail industry is lower than Tractor Supply's P/E.

Its relatively high P/E ratio indicates that Tractor Supply shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

Don't forget that the P/E ratio considers market capitalization. So it won't reflect the advantage of cash, or disadvantage of debt. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.

Tractor Supply's Balance Sheet

Net debt totals just 2.8% of Tractor Supply's market cap. The market might award it a higher P/E ratio if it had net cash, but its unlikely this low level of net borrowing is having a big impact on the P/E multiple.

The Bottom Line On Tractor Supply's P/E Ratio

Tractor Supply trades on a P/E ratio of 23.8, which is above the US market average of 18.2. Its debt levels do not imperil its balance sheet and its EPS growth is very healthy indeed. So on this analysis a high P/E ratio seems reasonable.

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 freereport on the analyst consensus forecasts could help you make a master move on this stock.

Of course you might be able to find a better stock than Tractor Supply. So you may wish to see this freecollection 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 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. Thank you for reading.