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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll look at Emerson Electric Co.’s (NYSE:EMR) P/E ratio and reflect on what it tells us about the company’s share price. Emerson Electric has a price to earnings ratio of 18.33, based on the last twelve months. In other words, at today’s prices, investors are paying $18.33 for every $1 in prior year profit.
How Do You Calculate Emerson Electric’s P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Emerson Electric:
P/E of 18.33 = $66.34 ÷ $3.62 (Based on the year to December 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each $1 the company has earned over the last year. 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
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. Then, a lower P/E should attract more buyers, pushing the share price up.
Notably, Emerson Electric grew EPS by a whopping 39% in the last year. And earnings per share have improved by 7.6% annually, over the last three years. I’d therefore be a little surprised if its P/E ratio was not relatively high. Unfortunately, earnings per share are down 1.8% a year, over 5 years.
How Does Emerson Electric’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 Emerson Electric has a higher P/E than the average (15.5) P/E for companies in the electrical industry.
That means that the market expects Emerson Electric will outperform other companies in its industry. Clearly the market expects growth, but it isn’t guaranteed. So investors 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
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. Thus, the metric does not reflect cash or debt held by the company. Theoretically, a business can improve its earnings (and produce a lower P/E in the future), by taking on debt (or spending its remaining 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).
Emerson Electric’s Balance Sheet
Net debt totals 11% of Emerson Electric’s 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 Emerson Electric’s P/E Ratio
Emerson Electric has a P/E of 18.3. That’s higher than the average in the US market, which is 16.8. The company is not overly constrained by its modest debt levels, and it is growing earnings per share. So it is not surprising the market is probably extrapolating recent growth well into the future, reflected in the relatively high P/E ratio.
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 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 Emerson Electric. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.