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Does Herbalife Nutrition Ltd.'s (NYSE:HLF) P/E Ratio Signal A Buying Opportunity?

Simply Wall St

Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll show how you can use Herbalife Nutrition Ltd.'s (NYSE:HLF) P/E ratio to inform your assessment of the investment opportunity. Herbalife Nutrition has a price to earnings ratio of 16.84, based on the last twelve months. That corresponds to an earnings yield of approximately 5.9%.

View our latest analysis for Herbalife Nutrition

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 Herbalife Nutrition:

P/E of 16.84 = $36.06 ÷ $2.14 (Based on the trailing twelve months to June 2019.)

Is A High P/E 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 isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.

How Does Herbalife Nutrition's P/E Ratio Compare To Its Peers?

The P/E ratio indicates whether the market has higher or lower expectations of a company. We can see in the image below that the average P/E (22.3) for companies in the personal products industry is higher than Herbalife Nutrition's P/E.

NYSE:HLF Price Estimation Relative to Market, August 15th 2019

Herbalife Nutrition'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 Herbalife Nutrition, it's quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

Herbalife Nutrition's earnings made like a rocket, taking off 89% last year. Having said that, if we look back three years, EPS growth has averaged a comparatively less impressive 12%. Regrettably, the longer term performance is poor, with EPS down 2.2% per year over 5 years.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

The 'Price' in P/E reflects the market capitalization of the company. That means it doesn't take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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.

How Does Herbalife Nutrition's Debt Impact Its P/E Ratio?

Herbalife Nutrition has net debt worth 24% of its market capitalization. This could bring some additional risk, and reduce the number of investment options for management; worth remembering if you compare its P/E to businesses without debt.

The Verdict On Herbalife Nutrition's P/E Ratio

Herbalife Nutrition's P/E is 16.8 which is about average (17.1) in the US market. When you consider the impressive EPS growth last year (along with some debt), it seems the market has questions about whether rapid EPS growth will be sustained. Because analysts are predicting more growth in the future, one might have expected to see a higher P/E ratio. You can taker closer look at the fundamentals, here.

When the market is wrong about a stock, it gives savvy investors an opportunity. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

But note: Herbalife Nutrition may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio 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 editorial-team@simplywallst.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.