This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll look at Zoetis Inc.’s (NYSE:ZTS) P/E ratio and reflect on what it tells us about the company’s share price. Based on the last twelve months, Zoetis’s P/E ratio is 31.73. That is equivalent to an earnings yield of about 3.2%.
How Do You Calculate Zoetis’s P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Zoetis:
P/E of 31.73 = $93.8 ÷ $2.96 (Based on the year to December 2018.)
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. 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.’
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. 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. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
Notably, Zoetis grew EPS by a whopping 68% in the last year. And earnings per share have improved by 23% annually, over the last five years. With that performance, I would expect it to have an above average P/E ratio.
How Does Zoetis’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. As you can see below, Zoetis has a higher P/E than the average company (19.3) in the pharmaceuticals industry.
That means that the market expects Zoetis will outperform other companies in its industry. Clearly the market expects growth, but it isn’t guaranteed. So investors 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
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).
Is Debt Impacting Zoetis’s P/E?
Zoetis’s net debt is 11% 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 Zoetis’s P/E Ratio
Zoetis’s P/E is 31.7 which is above average (17.7) in the US market. While the company does use modest debt, its recent earnings growth is impressive. Therefore it seems reasonable that the market would have relatively high expectations of the company
When the market is wrong about a stock, it gives savvy investors an opportunity. 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: Zoetis 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).
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