Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at Mercury Systems, Inc.'s (NASDAQ:MRCY) P/E ratio and reflect on what it tells us about the company's share price. Mercury Systems has a P/E ratio of 60.23, based on the last twelve months. That means that at current prices, buyers pay $60.23 for every $1 in trailing yearly profits.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Mercury Systems:
P/E of 60.23 = $70.99 ÷ $1.18 (Based on the year to September 2019.)
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 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 Mercury Systems'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. The image below shows that Mercury Systems has a higher P/E than the average (20.4) P/E for companies in the aerospace & defense industry.
That means that the market expects Mercury Systems will outperform other companies in its industry. Clearly the market expects growth, but it isn't guaranteed. So further research is always essential. 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 unless the share price increases, the P/E will reduce in a few years. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Mercury Systems's earnings made like a rocket, taking off 80% last year. Even better, EPS is up 27% per year over three years. So you might say it really deserves to have an above-average P/E ratio.
Remember: P/E Ratios Don't Consider The Balance Sheet
The 'Price' in P/E reflects the market capitalization of the company. So it won't reflect the advantage of cash, or disadvantage of debt. 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).
How Does Mercury Systems's Debt Impact Its P/E Ratio?
Since Mercury Systems holds net cash of US$161m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Bottom Line On Mercury Systems's P/E Ratio
With a P/E ratio of 60.2, Mercury Systems is expected to grow earnings very strongly in the years to come. The excess cash it carries is the gravy on top its fast EPS growth. So based on this analysis we'd expect Mercury Systems to have a high P/E ratio.
Investors have an opportunity when market expectations about a stock are wrong. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
But note: Mercury Systems 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).
If you spot an error that warrants correction, please contact the editor at email@example.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.
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