Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at Ubiquiti Networks, Inc.'s (NASDAQ:UBNT) P/E ratio and reflect on what it tells us about the company's share price. Based on the last twelve months, Ubiquiti Networks's P/E ratio is 30.38. That is equivalent to an earnings yield of about 3.3%.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Ubiquiti Networks:
P/E of 30.38 = $135.05 ÷ $4.44 (Based on the year to March 2019.)
Is A High P/E Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.'
Does Ubiquiti Networks Have A Relatively High Or Low P/E For Its Industry?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. As you can see below Ubiquiti Networks has a P/E ratio that is fairly close for the average for the communications industry, which is 30.4.
Ubiquiti Networks's P/E tells us that market participants think its prospects are roughly in line with its industry. If the company has better than average prospects, then the market might be underestimating it. I would further inform my view by checking insider buying and selling., among other things.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. Then, a lower P/E should attract more buyers, pushing the share price up.
Ubiquiti Networks's 87% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. The sweetener is that the annual five year growth rate of 20% is also impressive. With that kind of growth rate we would generally expect a high P/E ratio.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. That means it doesn't take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
Is Debt Impacting Ubiquiti Networks's P/E?
Ubiquiti Networks's net debt is 1.0% of its market cap. The market might award it a higher P/E ratio if it had net cash, but its unlikely this low level of net borrowing is having a big impact on the P/E multiple.
The Bottom Line On Ubiquiti Networks's P/E Ratio
Ubiquiti Networks's P/E is 30.4 which is above average (18) in its market. While the company does use modest debt, its recent earnings growth is superb. So on this analysis a high P/E ratio seems reasonable.
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 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 Ubiquiti Networks. So you may wish to see this free collection of other companies that have grown earnings strongly.
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.