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Is Check Point Software Technologies Ltd.'s (NASDAQ:CHKP) P/E Ratio Really That Good?

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 Check Point Software Technologies Ltd.'s (NASDAQ:CHKP) P/E ratio could help you assess the value on offer. Check Point Software Technologies has a P/E ratio of 22.61, based on the last twelve months. That means that at current prices, buyers pay $22.61 for every $1 in trailing yearly profits.

View our latest analysis for Check Point Software Technologies

How Do I Calculate Check Point Software Technologies's Price To Earnings Ratio?

The formula for price to earnings is:

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

Or for Check Point Software Technologies:

P/E of 22.61 = $117.16 ÷ $5.18 (Based on the year to September 2019.)

Is A High Price-to-Earnings 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.

How Does Check Point Software Technologies's P/E Ratio Compare To Its Peers?

The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that Check Point Software Technologies has a lower P/E than the average (45.6) P/E for companies in the software industry.

NasdaqGS:CHKP Price Estimation Relative to Market, November 26th 2019
NasdaqGS:CHKP Price Estimation Relative to Market, November 26th 2019

Its relatively low P/E ratio indicates that Check Point Software Technologies shareholders think it will struggle to do as well as other companies in its industry classification. Many investors like to buy stocks when the market is pessimistic about their prospects. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. And in that case, the P/E ratio itself will drop rather quickly. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

Check Point Software Technologies's earnings per share were pretty steady over the last year. But it has grown its earnings per share by 8.1% per year over the last five years.

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. So it won't reflect the advantage of cash, or disadvantage of debt. 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).

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.

So What Does Check Point Software Technologies's Balance Sheet Tell Us?

Check Point Software Technologies has net cash of US$1.7b. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.

The Verdict On Check Point Software Technologies's P/E Ratio

Check Point Software Technologies has a P/E of 22.6. That's higher than the average in its market, which is 18.3. Falling earnings per share is probably keeping traditional value investors away, but the relatively strong balance sheet will allow the company time to invest in growth. Clearly, the high P/E indicates shareholders think it will!

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.

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.

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.

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. Thank you for reading.

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