This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll look at ABIOMED Inc’s (NASDAQ:ABMD) P/E ratio and reflect on what it tells us about the company’s share price. ABIOMED has a price to earnings ratio of 89.03, based on the last twelve months. That is equivalent to an earnings yield of about 1.1%.
How Do You Calculate ABIOMED’s P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for ABIOMED:
P/E of 89.03 = $331.22 ÷ $3.72 (Based on the year to June 2018.)
Is A High P/E Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each $1 of company earnings. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
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. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
ABIOMED increased earnings per share by a whopping 111% last year. And it has bolstered its earnings per share by 32% per year over the last five years. I’d therefore be a little surprised if its P/E ratio was not relatively high.
How Does ABIOMED’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 ABIOMED has a higher P/E than the average (48.9) P/E for companies in the medical equipment industry.
Its relatively high P/E ratio indicates that ABIOMED 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 delve deeper. I like to check if company insiders have been buying or selling.
Remember: P/E Ratios Don’t Consider The Balance Sheet
Don’t forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. 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).
Is Debt Impacting ABIOMED’s P/E?
Since ABIOMED holds net cash of US$361m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Bottom Line On ABIOMED’s P/E Ratio
ABIOMED’s P/E is 89 which is way above average (18.4) in the US market. Its net cash position supports a higher P/E ratio, as does its solid recent earnings growth. So it does not seem strange that the P/E is above average.
Investors have an opportunity when market expectations about a stock are wrong. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
You might be able to find a better buy than ABIOMED. 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).
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.