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Is The Estée Lauder Companies Inc.'s (NYSE:EL) High P/E Ratio A Problem For Investors?

Simply Wall St

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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll show how you can use The Estée Lauder Companies Inc.'s (NYSE:EL) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Estée Lauder Companies's P/E ratio is 37.18. That corresponds to an earnings yield of approximately 2.7%.

See our latest analysis for Estée Lauder Companies

How Do You Calculate Estée Lauder Companies's P/E Ratio?

The formula for P/E is:

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

Or for Estée Lauder Companies:

P/E of 37.18 = $165.55 ÷ $4.45 (Based on the year to December 2018.)

Is A High P/E 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. 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.

Estée Lauder Companies increased earnings per share by a whopping 52% last year. And it has bolstered its earnings per share by 4.7% per year over the last five years. So we'd generally expect it to have a relatively high P/E ratio.

How Does Estée Lauder Companies's P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. As you can see below, Estée Lauder Companies has a higher P/E than the average company (24.7) in the personal products industry.

NYSE:EL Price Estimation Relative to Market, April 1st 2019

That means that the market expects Estée Lauder Companies 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.

Remember: P/E Ratios Don't Consider The Balance Sheet

The 'Price' in P/E reflects the market capitalization of the company. That means it doesn't take debt or cash into account. 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.

Estée Lauder Companies's Balance Sheet

Estée Lauder Companies has net debt worth just 1.7% of its market capitalization. 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 Estée Lauder Companies's P/E Ratio

Estée Lauder Companies's P/E is 37.2 which is above average (17.7) in the US market. The company is not overly constrained by its modest debt levels, and it is growing earnings per share. So it does not seem strange that the P/E is above average.

Investors have an opportunity when market expectations about a stock are wrong. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. 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.

You might be able to find a better buy than Estée Lauder Companies. 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.