Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at Ralph Lauren Corporation's (NYSE:RL) P/E ratio and reflect on what it tells us about the company's share price. Ralph Lauren has a price to earnings ratio of 17.01, based on the last twelve months. That means that at current prices, buyers pay $17.01 for every $1 in trailing yearly profits.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Ralph Lauren:
P/E of 17.01 = $93.72 ÷ $5.51 (Based on the trailing twelve months to June 2019.)
Is A High Price-to-Earnings 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 necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
Does Ralph Lauren 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 Ralph Lauren has a P/E ratio that is fairly close for the average for the luxury industry, which is 16.3.
Its P/E ratio suggests that Ralph Lauren shareholders think that in the future it will perform about the same as other companies in its industry classification. The company could surprise by performing better than average, in the future. Further research into factors such as insider buying and selling, could help you form your own view on whether that is likely.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. 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. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
Ralph Lauren's earnings made like a rocket, taking off 113% last year. Having said that, the average EPS growth over the last three years wasn't so good, coming in at 14%. Unfortunately, earnings per share are down 8.1% a year, over 5 years.
Remember: P/E Ratios Don't Consider The Balance Sheet
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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.
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.
So What Does Ralph Lauren's Balance Sheet Tell Us?
Ralph Lauren has net cash of US$1.2b. This is fairly high at 17% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.
The Verdict On Ralph Lauren's P/E Ratio
Ralph Lauren trades on a P/E ratio of 17, which is fairly close to the US market average of 17.4. The excess cash it carries is the gravy on top its fast EPS growth. So based on this analysis we'd expect Ralph Lauren to have a higher P/E ratio. All the more so, since analysts expect further profit growth. Click here to research this potential opportunity..
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 visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
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.