Despite Its High P/E Ratio, Is Heritage-Crystal Clean, Inc (NASDAQ:HCCI) Still Undervalued?
Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll apply a basic P/E ratio analysis to Heritage-Crystal Clean, Inc's (NASDAQ:HCCI), to help you decide if the stock is worth further research. What is Heritage-Crystal Clean's P/E ratio? Well, based on the last twelve months it is 55.73. In other words, at today's prices, investors are paying $55.73 for every $1 in prior year profit.
Check out our latest analysis for Heritage-Crystal Clean
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 Heritage-Crystal Clean:
P/E of 55.73 = $31.37 ÷ $0.56 (Based on the trailing twelve months to September 2019.)
Is A High P/E 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 is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
Does Heritage-Crystal Clean Have A Relatively High Or Low P/E For Its Industry?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. You can see in the image below that the average P/E (26.5) for companies in the commercial services industry is lower than Heritage-Crystal Clean's P/E.
That means that the market expects Heritage-Crystal Clean will outperform other companies in its industry. Clearly the market expects growth, but it isn't guaranteed. 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. 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.
Heritage-Crystal Clean's earnings per share fell by 46% in the last twelve months. But EPS is up 14% over the last 5 years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don't forget that the P/E ratio considers market capitalization. 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).
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).
Heritage-Crystal Clean's Balance Sheet
Since Heritage-Crystal Clean holds net cash of US$30m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Verdict On Heritage-Crystal Clean's P/E Ratio
Heritage-Crystal Clean has a P/E of 55.7. That's higher than the average in its market, which is 18.9. Falling earnings per share is probably keeping traditional value investors away, but the healthy balance sheet means the company retains potential for future growth. If fails to eventuate, the current high P/E could prove to be temporary, as the share price falls.
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 visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
Of course you might be able to find a better stock than Heritage-Crystal Clean. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.
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. Thank you for reading.
