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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll show how you can use Bristol-Myers Squibb Company's (NYSE:BMY) P/E ratio to inform your assessment of the investment opportunity. Looking at earnings over the last twelve months, Bristol-Myers Squibb has a P/E ratio of 14.4. That means that at current prices, buyers pay $14.4 for every $1 in trailing yearly profits.
How Do I Calculate Bristol-Myers Squibb's Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Bristol-Myers Squibb:
P/E of 14.4 = $45.35 ÷ $3.15 (Based on the trailing twelve months to March 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. That isn't necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. Then, a lower P/E should attract more buyers, pushing the share price up.
In the last year, Bristol-Myers Squibb grew EPS like Taylor Swift grew her fan base back in 2010; the 461% gain was both fast and well deserved. Even better, EPS is up 49% per year over three years. So you might say it really deserves to have an above-average P/E ratio.
Does Bristol-Myers Squibb 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. We can see in the image below that the average P/E (18.9) for companies in the pharmaceuticals industry is higher than Bristol-Myers Squibb's P/E.
Its relatively low P/E ratio indicates that Bristol-Myers Squibb shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Bristol-Myers Squibb, 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
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. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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.
Bristol-Myers Squibb's Balance Sheet
The extra options and safety that comes with Bristol-Myers Squibb's US$2.7b net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Bottom Line On Bristol-Myers Squibb's P/E Ratio
Bristol-Myers Squibb has a P/E of 14.4. That's below the average in the US market, which is 18.1. 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. Since analysts are predicting growth will continue, one might expect to see a higher P/E so it may be worth looking closer.
Investors should be looking to buy stocks that the market is wrong about. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. 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 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.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
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.