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 Genuine Parts Company’s (NYSE:GPC) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Genuine Parts’s P/E ratio is 19.75. That means that at current prices, buyers pay $19.75 for every $1 in trailing yearly profits.
How Do I Calculate Genuine Parts’s Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Genuine Parts:
P/E of 19.75 = $109.16 ÷ $5.53 (Based on the year to December 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each $1 the company has earned over the last year. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the ‘E’ will be higher. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
Genuine Parts increased earnings per share by a whopping 32% last year. And it has bolstered its earnings per share by 1.2% per year over the last five years. So we’d generally expect it to have a relatively high P/E ratio.
How Does Genuine Parts’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. The image below shows that Genuine Parts has a higher P/E than the average (17.8) P/E for companies in the retail distributors industry.
That means that the market expects Genuine Parts will outperform other companies in its industry. 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
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. 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.
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).
Genuine Parts’s Balance Sheet
Genuine Parts’s net debt is 18% of its market cap. 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 Verdict On Genuine Parts’s P/E Ratio
Genuine Parts trades on a P/E ratio of 19.8, which is above the US market average of 17.7. Its debt levels do not imperil its balance sheet and it has already proven it can grow. So it does not seem strange that the P/E is above average.
When the market is wrong about a stock, it gives savvy investors an opportunity. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
You might be able to find a better buy than Genuine Parts. 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 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.