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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we'll show how Ollie's Bargain Outlet Holdings, Inc.'s (NASDAQ:OLLI) P/E ratio could help you assess the value on offer. Looking at earnings over the last twelve months, Ollie's Bargain Outlet Holdings has a P/E ratio of 44.97. In other words, at today's prices, investors are paying $44.97 for every $1 in prior year profit.
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Ollie's Bargain Outlet Holdings:
P/E of 44.97 = $97.03 ÷ $2.16 (Based on the year to February 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each $1 of company earnings. 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 Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. And in that case, the P/E ratio itself will drop rather quickly. Then, a lower P/E should attract more buyers, pushing the share price up.
Ollie's Bargain Outlet Holdings's earnings per share grew by -4.1% in the last twelve months. And it has bolstered its earnings per share by 40% per year over the last five years.
How Does Ollie's Bargain Outlet Holdings's P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. As you can see below, Ollie's Bargain Outlet Holdings has a much higher P/E than the average company (10.6) in the multiline retail industry.
Its relatively high P/E ratio indicates that Ollie's Bargain Outlet Holdings 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.
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. 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).
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 Ollie's Bargain Outlet Holdings's P/E?
Since Ollie's Bargain Outlet Holdings holds net cash of US$51m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Bottom Line On Ollie's Bargain Outlet Holdings's P/E Ratio
Ollie's Bargain Outlet Holdings trades on a P/E ratio of 45, which is above the US market average of 17.3. EPS was up modestly better over the last twelve months. And the net cash position provides the company with multiple options. The high P/E suggests the market thinks further growth will come.
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 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 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. Thank you for reading.