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Despite Its High P/E Ratio, Is Fortune Brands Home & Security, Inc. (NYSE:FBHS) Still Undervalued?

Simply Wall St

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 Fortune Brands Home & Security, Inc.'s (NYSE:FBHS) P/E ratio could help you assess the value on offer. What is Fortune Brands Home & Security's P/E ratio? Well, based on the last twelve months it is 20.44. In other words, at today's prices, investors are paying $20.44 for every $1 in prior year profit.

View our latest analysis for Fortune Brands Home & Security

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 Fortune Brands Home & Security:

P/E of 20.44 = $60.36 ÷ $2.95 (Based on the year to September 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 Fortune Brands Home & Security's P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. The image below shows that Fortune Brands Home & Security has a P/E ratio that is roughly in line with the building industry average (20.7).

NYSE:FBHS Price Estimation Relative to Market, October 28th 2019

That indicates that the market expects Fortune Brands Home & Security will perform roughly in line with other companies in its industry. If the company has better than average prospects, then the market might be underestimating it. Checking factors such as director buying and selling. could help you form your own view on if that will happen.

How Growth Rates Impact P/E Ratios

Probably the most important factor in determining what P/E a company trades on is the earnings growth. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

Fortune Brands Home & Security's earnings per share were pretty steady over the last year. But it has grown its earnings per share by 14% per year over the last five 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. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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 Fortune Brands Home & Security's Debt Impact Its P/E Ratio?

Fortune Brands Home & Security's net debt is 22% of its market cap. It would probably deserve a higher P/E ratio if it was net cash, since it would have more options for growth.

The Bottom Line On Fortune Brands Home & Security's P/E Ratio

Fortune Brands Home & Security's P/E is 20.4 which is above average (17.8) in its market. With modest debt relative to its size, and modest earnings growth, the market is likely expecting sustained long-term growth, if not a near-term improvement.

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 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.