The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll look at International Business Machines Corporation's (NYSE:IBM) P/E ratio and reflect on what it tells us about the company's share price. International Business Machines has a P/E ratio of 20.03, based on the last twelve months. That means that at current prices, buyers pay $20.03 for every $1 in trailing yearly profits.
How Do I Calculate International Business Machines's Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for International Business Machines:
P/E of 20.03 = $124.79 ÷ $6.23 (Based on the trailing twelve months to September 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 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
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. That means even if the current P/E is low, it will increase over time if the share price stays flat. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
International Business Machines's earnings per share fell by 48% in the last twelve months. And EPS is down 16% a year, over the last 5 years. This might lead to muted expectations.
How Does International Business Machines's P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. The image below shows that International Business Machines has a lower P/E than the average (25) P/E for companies in the it industry.
NYSE:IBM PE PEG Gauge October 29th 18
Its relatively low P/E ratio indicates that International Business Machines shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The 'Price' in P/E reflects the market capitalization of the company. 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.
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
How Does International Business Machines's Debt Impact Its P/E Ratio?
Net debt totals 28% of International Business Machines's market cap. If you want to compare its P/E ratio to other companies, you should absolutely keep in mind it has significant borrowings.
The Bottom Line On International Business Machines's P/E Ratio
International Business Machines has a P/E of 20. That's higher than the average in the US market, which is 18.1. With a bit of debt, but a lack of recent growth, it's safe to say the market is expecting improved profit performance from the company, in the next few years.
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 freevisual report on analyst forecasts could hold they key to an excellent investment decision.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
About NYSE:IBM
International Business Machines
Provides integrated solutions and services in the Americas, Europe, the Middle East, Africa, and the Asia Pacific.
