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 Bio-Rad Laboratories, Inc.'s (NYSE:BIO) P/E ratio could help you assess the value on offer. Looking at earnings over the last twelve months, Bio-Rad Laboratories has a P/E ratio of 6.28. In other words, at today's prices, investors are paying $6.28 for every $1 in prior year profit.
How Do You Calculate Bio-Rad Laboratories's P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Bio-Rad Laboratories:
P/E of 6.28 = $370.370 ÷ $58.931 (Based on the trailing twelve months to December 2019.)
(Note: the above calculation results may not be precise due to rounding.)
Is A High P/E Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each $1 of company earnings. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price'.
Does Bio-Rad Laboratories Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. If you look at the image below, you can see Bio-Rad Laboratories has a lower P/E than the average (30.5) in the life sciences industry classification.
This suggests that market participants think Bio-Rad Laboratories 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. You should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
Bio-Rad Laboratories's earnings made like a rocket, taking off 381% last year. The sweetener is that the annual five year growth rate of 80% is also impressive. So I'd be surprised if the P/E ratio was not above average.
Remember: P/E Ratios Don't Consider The Balance Sheet
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.
Is Debt Impacting Bio-Rad Laboratories's P/E?
Since Bio-Rad Laboratories holds net cash of US$687m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Verdict On Bio-Rad Laboratories's P/E Ratio
Bio-Rad Laboratories's P/E is 6.3 which is below average (13.0) in the US market. It grew its EPS nicely over the last year, and the healthy balance sheet implies there is more potential for growth. The below average P/E ratio suggests that market participants don't believe the strong growth will continue.
Investors have an opportunity when market expectations about a stock are wrong. 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.
But note: Bio-Rad Laboratories may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
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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