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Despite Its High P/E Ratio, Is Park Aerospace Corp. (NYSE:PKE) Still Undervalued?

Simply Wall St

Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at Park Aerospace Corp.'s (NYSE:PKE) P/E ratio and reflect on what it tells us about the company's share price. Park Aerospace has a price to earnings ratio of 43.83, based on the last twelve months. That corresponds to an earnings yield of approximately 2.3%.

View our latest analysis for Park Aerospace

How Do You Calculate A P/E Ratio?

The formula for price to earnings is:

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

Or for Park Aerospace:

P/E of 43.83 = $17.67 ÷ $0.40 (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. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.'

How Does Park Aerospace's P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. As you can see below, Park Aerospace has a higher P/E than the average company (23.3) in the aerospace & defense industry.

NYSE:PKE Price Estimation Relative to Market, September 12th 2019

Park Aerospace's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Clearly the market expects growth, but it isn't guaranteed. So further research is always essential. I often monitor director buying and selling.

How Growth Rates Impact P/E Ratios

When earnings fall, the 'E' decreases, over time. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.

Park Aerospace saw earnings per share decrease by 58% last year. And it has shrunk its earnings per share by 20% per year over the last three years. This could justify a low P/E.

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

The 'Price' in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.

So What Does Park Aerospace's Balance Sheet Tell Us?

With net cash of US$151m, Park Aerospace has a very strong balance sheet, which may be important for its business. Having said that, at 42% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.

The Bottom Line On Park Aerospace's P/E Ratio

Park Aerospace trades on a P/E ratio of 43.8, which is above its market average of 18.2. The recent drop in earnings per share might keep 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.

When the market is wrong about a stock, it gives savvy investors an opportunity. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. Although we don't have analyst forecasts, shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.

You might be able to find a better buy than Park Aerospace. 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).

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.