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Despite Its High P/E Ratio, Is ABM Industries Incorporated (NYSE:ABM) Still Undervalued?

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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll show how you can use ABM Industries Incorporated's (NYSE:ABM) P/E ratio to inform your assessment of the investment opportunity. What is ABM Industries's P/E ratio? Well, based on the last twelve months it is 32.48. That corresponds to an earnings yield of approximately 3.1%.

Check out our latest analysis for ABM Industries

How Do I Calculate A Price To Earnings Ratio?

The formula for P/E is:

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

Or for ABM Industries:

P/E of 32.48 = $41.93 ÷ $1.29 (Based on the year to April 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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 ABM Industries's P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. The image below shows that ABM Industries has a higher P/E than the average (23.3) P/E for companies in the commercial services industry.

NYSE:ABM Price Estimation Relative to Market, July 19th 2019

That means that the market expects ABM Industries will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. So further research is always essential. I often monitor director buying and selling.

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. Earnings growth means that in the future the 'E' will be higher. 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.

ABM Industries shrunk earnings per share by 3.3% last year. But it has grown its earnings per share by 18% per year over the last three years.

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

The 'Price' in P/E reflects the market capitalization of the company. 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.

Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).

ABM Industries's Balance Sheet

ABM Industries has net debt equal to 33% of its market cap. While it's worth keeping this in mind, it isn't a worry.

The Verdict On ABM Industries's P/E Ratio

ABM Industries has a P/E of 32.5. That's higher than the average in its market, which is 17.9. 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. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

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.