The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll look at Ubiquiti Networks, Inc.’s (NASDAQ:UBNT) P/E ratio and reflect on what it tells us about the company’s share price. Based on the last twelve months, Ubiquiti Networks’s P/E ratio is 30.7. In other words, at today’s prices, investors are paying $30.7 for every $1 in prior year profit.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Ubiquiti Networks:
P/E of 30.7 = $139.58 ÷ $4.55 (Based on the year 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 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
Probably the most important factor in determining what P/E a company trades on is the earnings growth. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. 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.
Notably, Ubiquiti Networks grew EPS by a whopping 145% in the last year. And its annual EPS growth rate over 5 years is 14%. With that performance, I would expect it to have an above average P/E ratio.
How Does Ubiquiti Networks’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Ubiquiti Networks has a P/E ratio that is roughly in line with the communications industry average (30.6).
That indicates that the market expects Ubiquiti Networks will perform roughly in line with other companies in its industry. If the company has better than average prospects, then the market might be underestimating it. Checking factors such as the tenure of the board and management could help you form your own view on if that will happen.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don’t forget that the P/E ratio considers market capitalization. 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 spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
Ubiquiti Networks’s Balance Sheet
Net debt totals just 0.8% of Ubiquiti Networks’s market cap. So it doesn’t have as many options as it would with net cash, but its debt would not have much of an impact on its P/E ratio.
The Bottom Line On Ubiquiti Networks’s P/E Ratio
Ubiquiti Networks’s P/E is 30.7 which is above average (17.4) in the US market. While the company does use modest debt, its recent earnings growth is impressive. Therefore it seems reasonable that the market would have relatively high expectations of the company
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 free report on the analyst consensus forecasts could help you make a master move on this stock.
Of course you might be able to find a better stock than Ubiquiti Networks. So you may wish to see this free collection of other companies that have grown earnings strongly.
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