The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll look at Arrow Electronics, Inc.’s (NYSE:ARW) P/E ratio and reflect on what it tells us about the company’s share price. Based on the last twelve months, Arrow Electronics’s P/E ratio is 11.12. That means that at current prices, buyers pay $11.12 for every $1 in trailing yearly profits.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Arrow Electronics:
P/E of 11.12 = $68.24 ÷ $6.13 (Based on the trailing twelve months to September 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each $1 the company has earned over the last year. 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 even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
Arrow Electronics increased earnings per share by 6.5% last year. And its annual EPS growth rate over 5 years is 5.2%.
How Does Arrow Electronics’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. We can see in the image below that the average P/E (17.9) for companies in the electronic industry is higher than Arrow Electronics’s P/E.
Arrow Electronics’s P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Arrow Electronics, it’s quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
Remember: P/E Ratios Don’t Consider The Balance Sheet
The ‘Price’ in P/E reflects the market capitalization of the company. 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.
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.
Is Debt Impacting Arrow Electronics’s P/E?
Arrow Electronics’s net debt is 51% of its market cap. This is enough debt that you’d have to make some adjustments before using the P/E ratio to compare it to a company with net cash.
The Bottom Line On Arrow Electronics’s P/E Ratio
Arrow Electronics has a P/E of 11.1. That’s below the average in the US market, which is 16. It’s good to see EPS growth in the last 12 months, but the debt on the balance sheet might be muting expectations.
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.
Of course you might be able to find a better stock than Arrow Electronics. So you may wish to see this free collection of other companies that have grown earnings strongly.
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 email@example.com.