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 Steel Dynamics, Inc.'s (NASDAQ:STLD) P/E ratio could help you assess the value on offer. Based on the last twelve months, Steel Dynamics's P/E ratio is 8.68. That is equivalent to an earnings yield of about 11.5%.
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Steel Dynamics:
P/E of 8.68 = $31.89 ÷ $3.67 (Based on the trailing twelve months to September 2019.)
Is A High Price-to-Earnings Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing 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 Does Steel Dynamics's P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. The image below shows that Steel Dynamics has a lower P/E than the average (12.2) P/E for companies in the metals and mining industry.
Its relatively low P/E ratio indicates that Steel Dynamics shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Steel Dynamics, it's quite possible it could surprise on the upside. 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. When earnings grow, the 'E' increases, over time. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.
Steel Dynamics shrunk earnings per share by 33% over the last year. But EPS is up 27% over the last 5 years.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
The 'Price' in P/E reflects the market capitalization of the company. That means it doesn't take debt or cash into account. 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.
Steel Dynamics's Balance Sheet
Steel Dynamics's net debt is 18% 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 Verdict On Steel Dynamics's P/E Ratio
Steel Dynamics's P/E is 8.7 which is below average (18.2) in the US market. The debt levels are not a major concern, but the lack of EPS growth is likely weighing on sentiment.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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.
Of course you might be able to find a better stock than Steel Dynamics. 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 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. Thank you for reading.