Read This Before You Buy Apple Inc (NASDAQ:AAPL) Because Of Its P/E Ratio

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 Apple Inc’s (NASDAQ:AAPL) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Apple’s P/E ratio is 17.02. That corresponds to an earnings yield of approximately 5.9%.

View our latest analysis for Apple

How Do You Calculate Apple’s P/E Ratio?

The formula for price to earnings is:

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

Or for Apple:

P/E of 17.02 = $204.47 ÷ $12.01 (Based on the trailing twelve months to September 2018.)

Is A High P/E Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each $1 of company earnings. 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. When earnings grow, the ‘E’ increases, over time. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.

Notably, Apple grew EPS by a whopping 30% 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 Apple’s P/E Ratio Compare To Its Peers?

The P/E ratio indicates whether the market has higher or lower expectations of a company. We can see in the image below that the average P/E (22.8) for companies in the tech industry is higher than Apple’s P/E.

NasdaqGS:AAPL PE PEG Gauge November 12th 18
NasdaqGS:AAPL PE PEG Gauge November 12th 18

Its relatively low P/E ratio indicates that Apple shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Apple, it’s quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.

Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits

The ‘Price’ in P/E reflects the market capitalization of the company. That means it doesn’t take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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 Apple’s Debt Impact Its P/E Ratio?

Net debt totals just 5.0% of Apple’s market cap. It would probably trade on a higher P/E ratio if it had a lot of cash, but I doubt it is having a big impact.

The Verdict On Apple’s P/E Ratio

Apple trades on a P/E ratio of 17, which is fairly close to the US market average of 18.2. With only modest debt levels, and strong earnings growth, the market seems to doubt that the growth can be maintained.

When the market is wrong about a stock, it gives savvy investors an opportunity. 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: Apple 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).

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.