This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll look at HealthEquity, Inc.’s (NASDAQ:HQY) P/E ratio and reflect on what it tells us about the company’s share price. HealthEquity has a P/E ratio of 57.24, based on the last twelve months. That is equivalent to an earnings yield of about 1.7%.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for HealthEquity:
P/E of 57.24 = $62.09 ÷ $1.08 (Based on the year to October 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each $1 the company has earned over the last year. 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
Earnings growth rates have a big influence on P/E ratios. 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, HealthEquity grew EPS by a whopping 43% in the last year. And earnings per share have improved by 59% annually, over the last five years. So we’d generally expect it to have a relatively high P/E ratio.
How Does HealthEquity’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. The image below shows that HealthEquity has a higher P/E than the average (19.5) P/E for companies in the healthcare industry.
Its relatively high P/E ratio indicates that HealthEquity shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
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. That means it doesn’t take debt or cash into account. 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).
HealthEquity’s Balance Sheet
HealthEquity has net cash of US$330m. 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 HealthEquity’s P/E Ratio
HealthEquity’s P/E is 57.2 which is way above average (16.8) in the US market. 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. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
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.
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 email@example.com.