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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll show how you can use Check Point Software Technologies Ltd.'s (NASDAQ:CHKP) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Check Point Software Technologies's P/E ratio is 21.43. That is equivalent to an earnings yield of about 4.7%.
How Do You Calculate Check Point Software Technologies's P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Check Point Software Technologies:
P/E of 21.43 = $112.09 ÷ $5.23 (Based on the year to March 2019.)
Is A High P/E Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing 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. 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. Then, a lower P/E should attract more buyers, pushing the share price up.
Check Point Software Technologies's earnings per share grew by -4.3% in the last twelve months. And it has bolstered its earnings per share by 9.1% per year over the last five years.
How Does Check Point Software Technologies's P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. We can see in the image below that the average P/E (49.9) for companies in the software industry is higher than Check Point Software Technologies's P/E.
Check Point Software Technologies's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Check Point Software Technologies, it's quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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 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.
Is Debt Impacting Check Point Software Technologies's P/E?
Check Point Software Technologies has net cash of US$1.8b. This is fairly high at 10% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.
The Verdict On Check Point Software Technologies's P/E Ratio
Check Point Software Technologies's P/E is 21.4 which is above average (17.4) in the US market. Recent earnings growth wasn't bad. And the healthy balance sheet means the company can sustain growth while the P/E suggests shareholders think it will.
Investors should be looking to buy stocks that the market is wrong about. 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 visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
Of course you might be able to find a better stock than Check Point Software Technologies. So you may wish to see this free collection of other companies that have grown earnings strongly.
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 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.