This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll look at Gentex Corporation's (NASDAQ:GNTX) P/E ratio and reflect on what it tells us about the company's share price. Based on the last twelve months, Gentex's P/E ratio is 16.2. That is equivalent to an earnings yield of about 6.2%.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Gentex:
P/E of 16.2 = $26.7 ÷ $1.65 (Based on the year to June 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 isn't necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
How Does Gentex's P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. As you can see below Gentex has a P/E ratio that is fairly close for the average for the auto components industry, which is 15.5.
Its P/E ratio suggests that Gentex shareholders think that in the future it will perform about the same as other companies in its industry classification. If the company has better than average prospects, then the market might be underestimating it. I would further inform my view by checking insider buying and selling., among other things.
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. That means unless the share price increases, the P/E will reduce in a few years. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Gentex's earnings per share grew by -4.0% in the last twelve months. And it has bolstered its earnings per share by 12% per year over the last five years.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. So it won't reflect the advantage of cash, or disadvantage of debt. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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 Gentex's P/E?
Since Gentex holds net cash of US$451m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Verdict On Gentex's P/E Ratio
Gentex has a P/E of 16.2. That's around the same as the average in the US market, which is 17.4. Recent earnings growth wasn't bad. And the net cash position gives the company many options. The average P/E suggests the market isn't overly optimistic, though.
When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
Of course you might be able to find a better stock than Gentex. So you may wish to see this free collection of other companies that have grown earnings strongly.
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If you spot an error that warrants correction, please contact the editor at email@example.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.