This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll look at Addus HomeCare Corporation's (NASDAQ:ADUS) P/E ratio and reflect on what it tells us about the company's share price. Based on the last twelve months, Addus HomeCare's P/E ratio is 57.58. In other words, at today's prices, investors are paying $57.58 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 = Share Price ÷ Earnings per Share (EPS)
Or for Addus HomeCare:
P/E of 57.58 = $83.46 ÷ $1.45 (Based on the trailing twelve months to June 2019.)
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 isn't necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
How Does Addus HomeCare'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. The image below shows that Addus HomeCare has a higher P/E than the average (19.9) P/E for companies in the healthcare industry.
That means that the market expects Addus HomeCare will outperform other companies in its industry. 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.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. When earnings grow, the 'E' increases, over time. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.
Addus HomeCare's earnings per share grew by -5.7% in the last twelve months. And its annual EPS growth rate over 5 years is 7.5%.
Remember: P/E Ratios Don't Consider The Balance Sheet
The 'Price' in P/E reflects the market capitalization of the company. 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.
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.
How Does Addus HomeCare's Debt Impact Its P/E Ratio?
Addus HomeCare has net cash of US$18m. 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 Addus HomeCare's P/E Ratio
Addus HomeCare's P/E is 57.6 which suggests the market is more focussed on the future opportunity rather than the current level of earnings. Recent earnings growth wasn't bad. And the net cash position provides the company with multiple options. The high P/E suggests the market thinks further growth will come.
Investors have an opportunity when market expectations about a stock are wrong. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine.' So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
Of course you might be able to find a better stock than Addus HomeCare. So you may wish to see this free collection of other companies that have grown earnings strongly.
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If you spot an error that warrants correction, please contact the editor at email@example.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.