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Does Houlihan Lokey, Inc. (NYSE:HLI) Have A Good P/E Ratio?

Simply Wall St

Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. To keep it practical, we'll show how Houlihan Lokey, Inc.'s (NYSE:HLI) P/E ratio could help you assess the value on offer. Houlihan Lokey has a price to earnings ratio of 18.11, based on the last twelve months. That corresponds to an earnings yield of approximately 5.5%.

Check out our latest analysis for Houlihan Lokey

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 Houlihan Lokey:

P/E of 18.11 = $48.20 ÷ $2.66 (Based on the trailing twelve months to September 2019.)

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 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 Does Houlihan Lokey's P/E Ratio Compare To Its Peers?

One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. We can see in the image below that the average P/E (34.2) for companies in the capital markets industry is higher than Houlihan Lokey's P/E.

NYSE:HLI Price Estimation Relative to Market, December 19th 2019
NYSE:HLI Price Estimation Relative to Market, December 19th 2019

This suggests that market participants think Houlihan Lokey 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. 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

P/E ratios primarily reflect market expectations around earnings growth rates. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

Houlihan Lokey's earnings per share fell by 1.5% in the last twelve months. But over the longer term (5 years) earnings per share have increased by 8.9%.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

The 'Price' in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. 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 spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.

Houlihan Lokey's Balance Sheet

Houlihan Lokey has net cash of US$212m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.

The Verdict On Houlihan Lokey's P/E Ratio

Houlihan Lokey trades on a P/E ratio of 18.1, which is fairly close to the US market average of 18.8. Although the recent drop in earnings per share would keep the market cautious, the relatively strong balance sheet will allow the company to weather a storm; so it isn't very surprising to see that it has a P/E ratio close to the market average.

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 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 Houlihan Lokey. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.

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. Thank you for reading.