Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. To keep it practical, we'll show how Ritchie Bros. Auctioneers Incorporated's (NYSE:RBA) P/E ratio could help you assess the value on offer. Based on the last twelve months, Ritchie Bros. Auctioneers's P/E ratio is 35.75. That is equivalent to an earnings yield of about 2.8%.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Ritchie Bros. Auctioneers:
P/E of 35.75 = $43.79 ÷ $1.22 (Based on the trailing twelve months to September 2019.)
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. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
Does Ritchie Bros. Auctioneers 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. The image below shows that Ritchie Bros. Auctioneers has a higher P/E than the average (26.4) P/E for companies in the commercial services industry.
That means that the market expects Ritchie Bros. Auctioneers 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.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. Earnings growth means that in the future the 'E' will be higher. And in that case, the P/E ratio itself will drop rather quickly. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Ritchie Bros. Auctioneers saw earnings per share improve by -7.4% last year. And its annual EPS growth rate over 5 years is 6.5%.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The 'Price' in P/E reflects the market capitalization of the company. So it won't reflect the advantage of cash, or disadvantage of debt. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).
While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
How Does Ritchie Bros. Auctioneers's Debt Impact Its P/E Ratio?
Ritchie Bros. Auctioneers's net debt is 8.2% of its market cap. It would probably trade on a higher P/E ratio if it had a lot of cash, but I doubt it is having a big impact.
The Verdict On Ritchie Bros. Auctioneers's P/E Ratio
Ritchie Bros. Auctioneers has a P/E of 35.8. That's higher than the average in its market, which is 18.9. With modest debt relative to its size, and modest earnings growth, the market is likely expecting sustained long-term growth, if not a near-term improvement.
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.
But note: Ritchie Bros. Auctioneers 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).
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.
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. Thank you for reading.