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Despite Its High P/E Ratio, Is Republic Services, Inc. (NYSE:RSG) Still Undervalued?

Simply Wall St

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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll show how you can use Republic Services, Inc.'s (NYSE:RSG) P/E ratio to inform your assessment of the investment opportunity. Republic Services has a price to earnings ratio of 27.61, based on the last twelve months. In other words, at today's prices, investors are paying $27.61 for every $1 in prior year profit.

View our latest analysis for Republic Services

How Do I Calculate Republic Services's Price To Earnings Ratio?

The formula for price to earnings is:

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

Or for Republic Services:

P/E of 27.61 = $87.83 ÷ $3.18 (Based on the year to March 2019.)

Is A High Price-to-Earnings Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. 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.

How Does Republic Services'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 Republic Services has a higher P/E than the average (23.1) P/E for companies in the commercial services industry.

NYSE:RSG Price Estimation Relative to Market, July 18th 2019

Republic Services's P/E tells us that market participants think the company will perform better than its industry peers, going forward. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should delve deeper. I like to check if company insiders have been buying or 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. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.

Republic Services saw earnings per share decrease by 20% last year. But over the longer term (5 years) earnings per share have increased by 14%.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

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. 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.

Is Debt Impacting Republic Services's P/E?

Republic Services's net debt equates to 30% of its market capitalization. While that's enough to warrant consideration, it doesn't really concern us.

The Verdict On Republic Services's P/E Ratio

Republic Services trades on a P/E ratio of 27.6, which is above its market average of 17.9. With some debt but no EPS growth last year, the market has high expectations of future profits.

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 visual report on analyst forecasts could hold the key to an excellent investment decision.

But note: Republic Services may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio 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.