Today, we’ll introduce the concept of the P/E ratio for those who are learning about investing. We’ll look at NETGEAR, Inc.’s (NASDAQ:NTGR) P/E ratio and reflect on what it tells us about the company’s share price. Based on the last twelve months, NETGEAR’s P/E ratio is 26.18. In other words, at today’s prices, investors are paying $26.18 for every $1 in prior year profit.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for NETGEAR:
P/E of 26.18 = USD21.83 ÷ USD0.83 (Based on the trailing twelve months to December 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each USD1 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.
Does NETGEAR 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. The image below shows that NETGEAR has a P/E ratio that is roughly in line with the communications industry average (24.5).
That indicates that the market expects NETGEAR will perform roughly in line with other companies in its industry. So if NETGEAR actually outperforms its peers going forward, that should be a positive for the share price. I would further inform my view by checking insider buying and selling., among other things.
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.
In the last year, NETGEAR grew EPS like Taylor Swift grew her fan base back in 2010; the 52% gain was both fast and well deserved. The sweetener is that the annual five year growth rate of 28% is also impressive. With that kind of growth rate we would generally expect a high P/E ratio. Regrettably, the longer term performance is poor, with EPS down -28% per year over 3 years.
Remember: P/E Ratios Don’t Consider The Balance Sheet
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. That means it doesn’t take debt or cash into account. 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.
How Does NETGEAR’s Debt Impact Its P/E Ratio?
NETGEAR has net cash of US$205m. This is fairly high at 31% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.
The Verdict On NETGEAR’s P/E Ratio
NETGEAR trades on a P/E ratio of 26.2, which is above its market average of 18.3. The excess cash it carries is the gravy on top its fast EPS growth. So based on this analysis we’d expect NETGEAR to have a high P/E ratio.
Investors have an opportunity when market expectations about a stock are wrong. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
You might be able to find a better buy than NETGEAR. 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).
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.
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