This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we’ll show how DXC Technology Company’s (NYSE:DXC) P/E ratio could help you assess the value on offer. What is DXC Technology’s P/E ratio? Well, based on the last twelve months it is 9.3. That is equivalent to an earnings yield of about 11%.
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How Do You Calculate DXC Technology’s P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for DXC Technology:
P/E of 9.3 = $56.33 ÷ $6.05 (Based on the year to December 2018.)
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. 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 even if the current P/E is high, it will reduce over time if the share price stays flat. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
DXC Technology’s 78% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. And earnings per share have improved by 169% annually, over the last three years. So we’d absolutely expect it to have a relatively high P/E ratio.
Does DXC Technology Have A Relatively High Or Low P/E For Its Industry?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. The image below shows that DXC Technology has a lower P/E than the average (30.9) P/E for companies in the it industry.
Its relatively low P/E ratio indicates that DXC Technology shareholders think it will struggle to do as well as other companies in its industry classification. Many investors like to buy stocks when the market is pessimistic about their prospects. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
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. Thus, the metric does not reflect cash or debt held by the company. 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.
DXC Technology’s Balance Sheet
DXC Technology’s net debt equates to 34% of its market capitalization. While it’s worth keeping this in mind, it isn’t a worry.
The Verdict On DXC Technology’s P/E Ratio
DXC Technology trades on a P/E ratio of 9.3, which is below the US market average of 17.7. The company hasn’t stretched its balance sheet, and earnings growth was good last year. If the company can continue to grow earnings, then the current P/E may be unjustifiably low.
Investors have an opportunity when market expectations about a stock are wrong. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. 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.
Of course you might be able to find a better stock than DXC Technology. So you may wish to see this free collection 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 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.