This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). To keep it practical, we’ll show how e.l.f. Beauty, Inc.’s (NYSE:ELF) P/E ratio could help you assess the value on offer. e.l.f. Beauty has a P/E ratio of 16.32, based on the last twelve months. That means that at current prices, buyers pay $16.32 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 e.l.f. Beauty:
P/E of 16.32 = $9.6 ÷ $0.59 (Based on the trailing twelve months to September 2018.)
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. 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. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.
e.l.f. Beauty increased earnings per share by a whopping 42% last year. And earnings per share have improved by 109% annually, over the last five years. I’d therefore be a little surprised if its P/E ratio was not relatively high.
How Does e.l.f. Beauty’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. If you look at the image below, you can see e.l.f. Beauty has a lower P/E than the average (20.9) in the personal products industry classification.
Its relatively low P/E ratio indicates that e.l.f. Beauty shareholders think it will struggle to do as well as other companies in its industry classification. Many investors like to buy stocks when the market is pessimistic about their prospects. You should delve deeper. I like to check if company insiders have been buying or selling.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The ‘Price’ in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. 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.
e.l.f. Beauty’s Balance Sheet
e.l.f. Beauty’s net debt is 24% of its market cap. This could bring some additional risk, and reduce the number of investment options for management; worth remembering if you compare its P/E to businesses without debt.
The Verdict On e.l.f. Beauty’s P/E Ratio
e.l.f. Beauty trades on a P/E ratio of 16.3, which is fairly close to the US market average of 16.5. With only modest debt levels, and strong earnings growth, the market seems to doubt that the growth can be maintained.
Investors have an opportunity when market expectations about a stock are wrong. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free visual report on analyst forecasts could hold they key to an excellent investment decision.
You might be able to find a better buy than e.l.f. Beauty. 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).
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.