The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll show how you can use Strattec Security Corporation’s (NASDAQ:STRT) P/E ratio to inform your assessment of the investment opportunity. Strattec Security has a P/E ratio of 9.62, based on the last twelve months. That means that at current prices, buyers pay $9.62 for every $1 in trailing yearly profits.
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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 Strattec Security:
P/E of 9.62 = $35.16 ÷ $3.65 (Based on the year to September 2018.)
Is A High P/E 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 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 Growth Rates Impact P/E Ratios
When earnings fall, the ‘E’ decreases, over time. That means even if the current P/E is low, it will increase over time if the share price stays flat. Then, a higher P/E might scare off shareholders, pushing the share price down.
It’s nice to see that Strattec Security grew EPS by a stonking 62% in the last year. In contrast, EPS has decreased by 15%, annually, over 5 years.
How Does Strattec Security’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 (13.6) for companies in the auto components industry is higher than Strattec Security’s P/E.
Its relatively low P/E ratio indicates that Strattec Security shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Strattec Security, it’s quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.
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. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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.
Is Debt Impacting Strattec Security’s P/E?
Strattec Security’s net debt is 31% of its market cap. If you want to compare its P/E ratio to other companies, you should absolutely keep in mind it has significant borrowings.
The Verdict On Strattec Security’s P/E Ratio
Strattec Security trades on a P/E ratio of 9.6, which is below the US market average of 17.1. 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.
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.’ We don’t have analyst forecasts, but you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.
Of course you might be able to find a better stock than Strattec Security. So you may wish to see this free collection of other companies that have grown earnings strongly.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.