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Today, we’ll introduce the concept of the P/E ratio for those who are learning about investing. We’ll look at MKS Instruments, Inc.’s (NASDAQ:MKSI) P/E ratio and reflect on what it tells us about the company’s share price. What is MKS Instruments’s P/E ratio? Well, based on the last twelve months it is 14.1. In other words, at today’s prices, investors are paying $14.1 for every $1 in prior year profit.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for MKS Instruments:
P/E of 14.1 = $77.89 ÷ $5.53 (Based on the trailing twelve months to March 2019.)
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 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
P/E ratios primarily reflect market expectations around earnings growth rates. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. 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.
MKS Instruments shrunk earnings per share by 21% over the last year. But over the longer term (5 years) earnings per share have increased by 37%.
Does MKS Instruments Have A Relatively High Or Low P/E For Its Industry?
We can get an indication of market expectations by looking at the P/E ratio. We can see in the image below that the average P/E (22.2) for companies in the semiconductor industry is higher than MKS Instruments’s P/E.
MKS Instruments’s P/E tells us that market participants think it will not fare as well as its peers in the same industry.
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. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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).
How Does MKS Instruments’s Debt Impact Its P/E Ratio?
Net debt totals 12% of MKS Instruments’s market cap. It would probably deserve a higher P/E ratio if it was net cash, since it would have more options for growth.
The Verdict On MKS Instruments’s P/E Ratio
MKS Instruments has a P/E of 14.1. That’s below the average in the US market, which is 18.1. The debt levels are not a major concern, but the lack of EPS growth is likely weighing on sentiment.
Investors have an opportunity when market expectations about a stock are wrong. 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 free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
But note: MKS Instruments 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).
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.