This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll look at Deckers Outdoor Corporation's (NYSE:DECK) P/E ratio and reflect on what it tells us about the company's share price. Deckers Outdoor has a price to earnings ratio of 14.50, based on the last twelve months. That is equivalent to an earnings yield of about 6.9%.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Deckers Outdoor:
P/E of 14.50 = $136.25 ÷ $9.40 (Based on the trailing twelve months to June 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 Deckers Outdoor'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 (16.9) for companies in the luxury industry is higher than Deckers Outdoor's P/E.
Its relatively low P/E ratio indicates that Deckers Outdoor shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Deckers Outdoor, it's quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
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. When earnings grow, the 'E' increases, over time. That means unless the share price increases, the P/E will reduce in a few years. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Deckers Outdoor's earnings made like a rocket, taking off 134% last year. The cherry on top is that the five year growth rate was an impressive 19% per year. So I'd be surprised if the P/E ratio was not above average.
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. That means it doesn't take debt or cash into account. 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).
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).
Deckers Outdoor's Balance Sheet
With net cash of US$471m, Deckers Outdoor has a very strong balance sheet, which may be important for its business. Having said that, at 12% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Bottom Line On Deckers Outdoor's P/E Ratio
Deckers Outdoor trades on a P/E ratio of 14.5, which is below the US market average of 17.9. It grew its EPS nicely over the last year, and the healthy balance sheet implies there is more potential for growth. The relatively low P/E ratio implies the market is pessimistic.
When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. 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 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.