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Don't Sell Gentherm Incorporated (NASDAQ:THRM) Before You Read This

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Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll show how you can use Gentherm Incorporated's (NASDAQ:THRM) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Gentherm's P/E ratio is 38.41. That corresponds to an earnings yield of approximately 2.6%.

View our latest analysis for Gentherm

How Do You Calculate A P/E Ratio?

The formula for P/E is:

Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)

Or for Gentherm:

P/E of 38.41 = $40.84 ÷ $1.06 (Based on the trailing twelve months to March 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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 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. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.

Gentherm's 71% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. On the other hand, the longer term performance is poor, with EPS down 2.2% per year over 5 years.

Does Gentherm Have A Relatively High Or Low P/E For Its Industry?

We can get an indication of market expectations by looking at the P/E ratio. As you can see below, Gentherm has a higher P/E than the average company (14.9) in the auto components industry.

NasdaqGS:THRM Price Estimation Relative to Market, July 5th 2019

That means that the market expects Gentherm will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. 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.

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.

Gentherm's Balance Sheet

Gentherm has net debt worth just 4.5% of its market capitalization. So it doesn't have as many options as it would with net cash, but its debt would not have much of an impact on its P/E ratio.

The Bottom Line On Gentherm's P/E Ratio

Gentherm trades on a P/E ratio of 38.4, which is above the US market average of 18.2. While the company does use modest debt, its recent earnings growth is superb. So on this analysis a high P/E ratio seems reasonable.

Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

You might be able to find a better buy than Gentherm. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

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 editorial-team@simplywallst.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.