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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we'll show how HNI Corporation's (NYSE:HNI) P/E ratio could help you assess the value on offer. HNI has a P/E ratio of 17.04, based on the last twelve months. That is equivalent to an earnings yield of about 5.9%.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for HNI:
P/E of 17.04 = $36.47 ÷ $2.14 (Based on the trailing twelve months to December 2018.)
Is A High Price-to-Earnings 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 Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. That means even if the current P/E is low, it will increase over time if the share price stays flat. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
HNI increased earnings per share by 4.8% last year. And earnings per share have improved by 6.0% annually, over the last five years. In contrast, EPS has decreased by 6.3%, annually, over 3 years.
How Does HNI's P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. If you look at the image below, you can see HNI has a lower P/E than the average (20.2) in the commercial services industry classification.
This suggests that market participants think HNI will underperform other companies in its industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. You should delve deeper. I like to check if company insiders have been buying or selling.
Remember: P/E Ratios Don't Consider The Balance Sheet
The 'Price' in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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).
Is Debt Impacting HNI's P/E?
HNI's net debt is 11% of its market cap. That's enough debt to impact the P/E ratio a little; so keep it in mind if you're comparing it to companies without debt.
The Bottom Line On HNI's P/E Ratio
HNI's P/E is 17 which is about average (17.7) in the US market. When you consider the modest EPS growth last year (along with some debt), it seems the market thinks the growth is sustainable.
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.
You might be able to find a better buy than HNI. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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.