Should We Worry About Analog Devices, Inc.’s (NASDAQ:ADI) P/E Ratio?

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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 Analog Devices, Inc.’s (NASDAQ:ADI) P/E ratio to inform your assessment of the investment opportunity. Analog Devices has a P/E ratio of 27.56, based on the last twelve months. That is equivalent to an earnings yield of about 3.6%.

Check out our latest analysis for Analog Devices

How Do You Calculate Analog Devices’s P/E Ratio?

The formula for P/E is:

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

Or for Analog Devices:

P/E of 27.56 = $113.17 ÷ $4.11 (Based on the trailing twelve months to May 2019.)

Is A High Price-to-Earnings Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. That isn’t a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business’s prospects, relative to stocks with a lower P/E.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. 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. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

It’s nice to see that Analog Devices grew EPS by a stonking 37% in the last year. And earnings per share have improved by 12% annually, over the last five years. So we’d generally expect it to have a relatively high P/E ratio.

How Does Analog Devices’s P/E Ratio Compare To Its Peers?

One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. As you can see below, Analog Devices has a higher P/E than the average company (22.9) in the semiconductor industry.

NasdaqGS:ADI Price Estimation Relative to Market, July 5th 2019
NasdaqGS:ADI Price Estimation Relative to Market, July 5th 2019

That means that the market expects Analog Devices will outperform other companies in its industry.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. 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 spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.

Is Debt Impacting Analog Devices’s P/E?

Analog Devices has net debt worth 13% of its market capitalization. This could bring some additional risk, and reduce the number of investment options for management; worth remembering if you compare its P/E to businesses without debt.

The Verdict On Analog Devices’s P/E Ratio

Analog Devices trades on a P/E ratio of 27.6, 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 to be frank we are not surprised it has a high P/E ratio.

When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

You might be able to find a better buy than Analog Devices. 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 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.