This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll look at F5 Networks, Inc.’s (NASDAQ:FFIV) P/E ratio and reflect on what it tells us about the company’s share price. F5 Networks has a P/E ratio of 18.82, based on the last twelve months. That is equivalent to an earnings yield of about 5.3%.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for F5 Networks:
P/E of 18.82 = $153.69 ÷ $8.17 (Based on the trailing twelve months to December 2018.)
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 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
Earnings growth rates have a big influence on P/E ratios. Earnings growth means that in the future the ‘E’ will be higher. That means unless the share price increases, the P/E will reduce in a few years. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
F5 Networks increased earnings per share by an impressive 25% over the last twelve months. And it has bolstered its earnings per share by 15% per year over the last five years. This could arguably justify a relatively high P/E ratio.
How Does F5 Networks’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 (30.4) for companies in the communications industry is higher than F5 Networks’s P/E.
This suggests that market participants think F5 Networks will underperform other companies in its industry. 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.
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. 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).
F5 Networks’s Balance Sheet
Since F5 Networks holds net cash of US$1.1b, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Verdict On F5 Networks’s P/E Ratio
F5 Networks trades on a P/E ratio of 18.8, which is fairly close to the US market average of 17.6. The balance sheet is healthy, and recent EPS growth impressive, but the P/E implies some caution from the market.
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 visual report on analyst forecasts could hold the key to an excellent investment decision.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
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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.