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Despite Its High P/E Ratio, Is TransDigm Group Incorporated (NYSE:TDG) Still Undervalued?

Simply Wall St

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 TransDigm Group Incorporated's (NYSE:TDG) P/E ratio to inform your assessment of the investment opportunity. What is TransDigm Group's P/E ratio? Well, based on the last twelve months it is 38.39. That is equivalent to an earnings yield of about 2.6%.

See our latest analysis for TransDigm Group

How Do You Calculate TransDigm Group's P/E Ratio?

The formula for P/E is:

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

Or for TransDigm Group:

P/E of 38.39 = $512.51 ÷ $13.35 (Based on the trailing twelve months 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 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 TransDigm Group'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 TransDigm Group has a higher P/E than the average (23.2) P/E for companies in the aerospace & defense industry.

NYSE:TDG Price Estimation Relative to Market, August 28th 2019

Its relatively high P/E ratio indicates that TransDigm Group 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.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the 'E' increases, over time. That means even if the current P/E is high, it will reduce over time if the share price stays flat. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

TransDigm Group shrunk earnings per share by 7.0% last year. But EPS is up 66% over the last 5 years.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

Don't forget that the P/E ratio considers market capitalization. That means it doesn't take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

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).

TransDigm Group's Balance Sheet

Net debt totals 52% of TransDigm Group's market cap. This is enough debt that you'd have to make some adjustments before using the P/E ratio to compare it to a company with net cash.

The Bottom Line On TransDigm Group's P/E Ratio

TransDigm Group has a P/E of 38.4. That's higher than the average in its market, which is 17. With significant debt and no EPS growth last year, shareholders are betting on an improvement in earnings from the company.

Investors have an opportunity when market expectations about a stock are wrong. 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 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.

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.