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Does Leidos Holdings, Inc.'s (NYSE:LDOS) P/E Ratio Signal A Buying Opportunity?

Simply Wall St

This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll show how you can use Leidos Holdings, Inc.'s (NYSE:LDOS) P/E ratio to inform your assessment of the investment opportunity. Looking at earnings over the last twelve months, Leidos Holdings has a P/E ratio of 18.45. That corresponds to an earnings yield of approximately 5.4%.

View our latest analysis for Leidos Holdings

How Do You Calculate Leidos Holdings's P/E Ratio?

The formula for P/E is:

Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)

Or for Leidos Holdings:

P/E of 18.45 = $82.82 ÷ $4.49 (Based on the year to June 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 is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.

How Does Leidos Holdings'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 Leidos Holdings has a lower P/E than the average (32.6) P/E for companies in the it industry.

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

Its relatively low P/E ratio indicates that Leidos Holdings shareholders think it will struggle to do as well as other companies in its industry classification. Many investors like to buy stocks when the market is pessimistic about their prospects. 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. Earnings growth means that in the future the 'E' will be higher. That means even if the current P/E is high, it will reduce over time if the share price stays flat. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

In the last year, Leidos Holdings grew EPS like Taylor Swift grew her fan base back in 2010; the 55% gain was both fast and well deserved. Having said that, the average EPS growth over the last three years wasn't so good, coming in at 2.9%.

Remember: P/E Ratios Don't Consider The Balance Sheet

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. In other words, it does not consider any debt or cash that the company may have on the balance sheet. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

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 Leidos Holdings's P/E?

Net debt totals 20% of Leidos Holdings's market cap. 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 Bottom Line On Leidos Holdings's P/E Ratio

Leidos Holdings trades on a P/E ratio of 18.4, which is above its market average of 17.1. While the company does use modest debt, its recent earnings growth is superb. So to be frank we are not surprised it has a high P/E ratio.

Investors should be looking to buy stocks that the market is wrong about. 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 report on the analyst consensus forecasts could help you make a master move on this stock.

Of course you might be able to find a better stock than Leidos Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.