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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). To keep it practical, we'll show how Casa Systems, Inc.'s (NASDAQ:CASA) P/E ratio could help you assess the value on offer. What is Casa Systems's P/E ratio? Well, based on the last twelve months it is 27.2. That means that at current prices, buyers pay $27.2 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 Casa Systems:
P/E of 27.2 = $6.39 ÷ $0.23 (Based on the trailing twelve months to June 2019.)
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. 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 Casa Systems Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. The image below shows that Casa Systems has a lower P/E than the average (30.9) P/E for companies in the communications industry.
Its relatively low P/E ratio indicates that Casa Systems shareholders think it will struggle to do as well as other companies in its industry classification. 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
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. That means unless the share price falls, the P/E will increase in a few years. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
Casa Systems's earnings per share fell by 74% in the last twelve months. And it has shrunk its earnings per share by 21% per year over the last five years. This growth rate might warrant a below average P/E ratio.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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.
Casa Systems's Balance Sheet
Casa Systems has net debt equal to 31% of its market cap. You'd want to be aware of this fact, but it doesn't bother us.
The Bottom Line On Casa Systems's P/E Ratio
Casa Systems trades on a P/E ratio of 27.2, which is above its market average of 17.4. With modest debt but no EPS growth in the last year, it's fair to say the P/E implies some optimism about future earnings, from the market.
Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. 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.
You might be able to find a better buy than Casa Systems. 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).
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 email@example.com. 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.