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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 AstroNova, Inc.’s (NASDAQ:ALOT) P/E ratio could help you assess the value on offer. What is AstroNova’s P/E ratio? Well, based on the last twelve months it is 27.02. That corresponds to an earnings yield of approximately 3.7%.
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for AstroNova:
P/E of 27.02 = $25.81 ÷ $0.96 (Based on the year to May 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each $1 of company earnings. 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
Probably the most important factor in determining what P/E a company trades on is the earnings growth. If earnings are growing quickly, then the ‘E’ in the equation will increase faster than it would otherwise. And in that case, the P/E ratio itself will drop rather quickly. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
AstroNova’s 78% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. The sweetener is that the annual five year growth rate of 21% is also impressive. With that kind of growth rate we would generally expect a high P/E ratio.
Does AstroNova Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio indicates whether the market has higher or lower expectations of a company. As you can see below, AstroNova has a higher P/E than the average company (17.8) in the tech industry.
That means that the market expects AstroNova will outperform other companies in its industry. Clearly the market expects growth, but it isn’t guaranteed. So further research is always essential. I often monitor director buying and selling.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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 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.
So What Does AstroNova’s Balance Sheet Tell Us?
Net debt totals just 7.0% of AstroNova’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 AstroNova’s P/E Ratio
AstroNova trades on a P/E ratio of 27, which is above the US market average of 17.9. 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.
Investors should be looking to buy stocks that the market is wrong about. 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 visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
You might be able to find a better buy than AstroNova. 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 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.