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Is Catalent, Inc.'s (NYSE:CTLT) High P/E Ratio A Problem For Investors?

Simply Wall St

Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll apply a basic P/E ratio analysis to Catalent, Inc.'s (NYSE:CTLT), to help you decide if the stock is worth further research. What is Catalent's P/E ratio? Well, based on the last twelve months it is 53.66. In other words, at today's prices, investors are paying $53.66 for every $1 in prior year profit.

See our latest analysis for Catalent

How Do I Calculate A Price To Earnings Ratio?

The formula for P/E is:

Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)

Or for Catalent:

P/E of 53.66 = $49.10 ÷ $0.92 (Based on the trailing twelve months to June 2019.)

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 isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.

Does Catalent Have A Relatively High Or Low P/E For Its Industry?

One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. As you can see below, Catalent has a much higher P/E than the average company (16.0) in the pharmaceuticals industry.

NYSE:CTLT Price Estimation Relative to Market, October 7th 2019

Its relatively high P/E ratio indicates that Catalent shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. So investors should delve deeper. I like to check if company insiders have been buying or selling.

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. And in that case, the P/E ratio itself will drop rather quickly. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

It's nice to see that Catalent grew EPS by a stonking 44% in the last year. And earnings per share have improved by 29% annually, over the last five years. With that performance, I would expect it to have an above average P/E ratio.

Remember: P/E Ratios Don't Consider The Balance Sheet

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. So it won't reflect the advantage of cash, or disadvantage of debt. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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.

How Does Catalent's Debt Impact Its P/E Ratio?

Catalent's net debt equates to 34% of its market capitalization. While that's enough to warrant consideration, it doesn't really concern us.

The Bottom Line On Catalent's P/E Ratio

Catalent's P/E is 53.7 which suggests the market is more focussed on the future opportunity rather than the current level of earnings. While the company does use modest debt, its recent earnings growth is superb. So on this analysis a high P/E ratio seems reasonable.

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 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 editorial-team@simplywallst.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.