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Does M.D.C. Holdings, Inc.'s (NYSE:MDC) P/E Ratio Signal A Buying Opportunity?

Simply Wall St

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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 M.D.C. Holdings, Inc.'s (NYSE:MDC) P/E ratio and reflect on what it tells us about the company's share price. Based on the last twelve months, M.D.C. Holdings's P/E ratio is 10.74. That corresponds to an earnings yield of approximately 9.3%.

See our latest analysis for M.D.C. Holdings

How Do You Calculate A P/E Ratio?

The formula for P/E is:

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

Or for M.D.C. Holdings:

P/E of 10.74 = $37.38 ÷ $3.48 (Based on the year to March 2019.)

Is A High P/E Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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 M.D.C. Holdings's P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. We can see in the image below that the average P/E (13.1) for companies in the consumer durables industry is higher than M.D.C. Holdings's P/E.

NYSE:MDC Price Estimation Relative to Market, July 17th 2019

Its relatively low P/E ratio indicates that M.D.C. Holdings shareholders think it will struggle to do as well as other companies in its industry classification. 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

Probably the most important factor in determining what P/E a company trades on is the earnings growth. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. 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.

It's nice to see that M.D.C. Holdings grew EPS by a stonking 33% in the last year. And its annual EPS growth rate over 3 years is 46%. I'd therefore be a little surprised if its P/E ratio was not relatively high. But earnings per share are down 7.1% per year over the last five years.

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

Don't forget that the P/E ratio considers market capitalization. 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).

M.D.C. Holdings's Balance Sheet

M.D.C. Holdings has net debt equal to 29% of its market cap. You'd want to be aware of this fact, but it doesn't bother us.

The Bottom Line On M.D.C. Holdings's P/E Ratio

M.D.C. Holdings trades on a P/E ratio of 10.7, which is below the US market average of 18. The EPS growth last year was strong, and debt levels are quite reasonable. If the company can continue to grow earnings, then the current P/E may be unjustifiably low.

Investors should be looking to buy stocks that the market is wrong about. 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 M.D.C. 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.