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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 look at Xilinx, Inc.’s (NASDAQ:XLNX) P/E ratio and reflect on what it tells us about the company’s share price. Xilinx has a price to earnings ratio of 33.94, based on the last twelve months. That is equivalent to an earnings yield of about 2.9%.
How Do You Calculate Xilinx’s P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Xilinx:
P/E of 33.94 = $112.73 ÷ $3.32 (Based on the trailing twelve months to December 2018.)
Is A High P/E Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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 Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. When earnings grow, the ‘E’ increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
Notably, Xilinx grew EPS by a whopping 75% in the last year. And it has improved its earnings per share by 5.9% per year over the last three years. I’d therefore be a little surprised if its P/E ratio was not relatively high.
How Does Xilinx’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. You can see in the image below that the average P/E (16) for companies in the semiconductor industry is lower than Xilinx’s P/E.
Its relatively high P/E ratio indicates that Xilinx shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn’t guaranteed. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. 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 taking on debt (or spending its remaining cash).
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
How Does Xilinx’s Debt Impact Its P/E Ratio?
Since Xilinx holds net cash of US$1.7b, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Bottom Line On Xilinx’s P/E Ratio
Xilinx trades on a P/E ratio of 33.9, which is above the US market average of 16.8. Its strong balance sheet gives the company plenty of resources for extra growth, and it has already proven it can grow. So it does not seem strange that the P/E is above average.
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.
You might be able to find a better buy than Xilinx. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.