This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). To keep it practical, we'll show how ExlService Holdings, Inc.'s (NASDAQ:EXLS) P/E ratio could help you assess the value on offer. ExlService Holdings has a price to earnings ratio of 47.70, based on the last twelve months. That means that at current prices, buyers pay $47.70 for every $1 in trailing yearly profits.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for ExlService Holdings:
P/E of 47.70 = $69.58 ÷ $1.46 (Based on the trailing twelve months to September 2019.)
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 Does ExlService Holdings's P/E Ratio Compare To Its Peers?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. As you can see below, ExlService Holdings has a higher P/E than the average company (30.9) in the it industry.
Its relatively high P/E ratio indicates that ExlService Holdings shareholders think it will perform better than other companies in its industry classification. The market is optimistic about the future, but that doesn't guarantee future growth. 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
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. That means unless the share price falls, the P/E will increase in a few years. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
Most would be impressed by ExlService Holdings earnings growth of 15% in the last year. And its annual EPS growth rate over 5 years is 3.2%. With that performance, you might expect an above average P/E ratio. Unfortunately, earnings per share are down 7.2% a year, over 3 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. So it won't reflect the advantage of cash, or disadvantage of debt. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on 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).
How Does ExlService Holdings's Debt Impact Its P/E Ratio?
ExlService Holdings has net cash of US$36m. 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 ExlService Holdings's P/E Ratio
ExlService Holdings trades on a P/E ratio of 47.7, which is above its market average of 18.9. With cash in the bank the company has plenty of growth options -- and it is already on the right track. So it is not surprising the market is probably extrapolating recent growth well into the future, reflected in the relatively high P/E ratio.
Investors have an opportunity when market expectations about a stock are wrong. 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 visual report on analyst forecasts could hold the key to an excellent investment decision.
You might be able to find a better buy than ExlService Holdings. 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).
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.
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