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Is Celestica Inc.'s (TSE:CLS) P/E Ratio Really That Good?

Simply Wall St

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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 Celestica Inc.'s (TSE:CLS), to help you decide if the stock is worth further research. Based on the last twelve months, Celestica's P/E ratio is 5.21. That means that at current prices, buyers pay CA$5.21 for every CA$1 in trailing yearly profits.

View our latest analysis for Celestica

How Do I Calculate A Price To Earnings Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)

Or for Celestica:

P/E of 5.21 = $6.62 (Note: this is the share price in the reporting currency, namely, USD ) ÷ $1.27 (Based on the year to March 2019.)

Is A High P/E Ratio Good?

A higher P/E ratio means that buyers have to pay a higher price for each CA$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.

Does Celestica 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. The image below shows that Celestica has a lower P/E than the average (15.3) P/E for companies in the electronic industry.

TSX:CLS Price Estimation Relative to Market, July 15th 2019

This suggests that market participants think Celestica will underperform other companies in its industry. Since the market seems unimpressed with Celestica, it's quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.

How Growth Rates Impact P/E Ratios

Probably the most important factor in determining what P/E a company trades on is the earnings growth. 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. Then, a lower P/E should attract more buyers, pushing the share price up.

Celestica's 87% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. And earnings per share have improved by 37% annually, over the last three years. So we'd absolutely expect it to have a relatively high 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. Thus, the metric does not reflect cash or debt held by the company. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).

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.

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

Celestica's net debt equates to 43% of its market capitalization. While it's worth keeping this in mind, it isn't a worry.

The Verdict On Celestica's P/E Ratio

Celestica's P/E is 5.2 which is below average (15) in the CA market. The company hasn't stretched its balance sheet, and earnings growth was good last year. If it continues to grow, then the current low P/E may prove to be unjustified.

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 Celestica. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.