This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll look at Abbott Laboratories's (NYSE:ABT) P/E ratio and reflect on what it tells us about the company's share price. Based on the last twelve months, Abbott Laboratories's P/E ratio is 49.86. That means that at current prices, buyers pay $49.86 for every $1 in trailing yearly profits.
How Do I Calculate Abbott Laboratories's Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Abbott Laboratories:
P/E of 49.86 = $81.07 ÷ $1.63 (Based on the year 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 is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
How Does Abbott Laboratories's P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. You can see in the image below that the average P/E (40.1) for companies in the medical equipment industry is lower than Abbott Laboratories's P/E.
Its relatively high P/E ratio indicates that Abbott Laboratories shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn't guaranteed. 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
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. That means unless the share price increases, the P/E will reduce in a few years. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Abbott Laboratories's earnings made like a rocket, taking off 251% last year. Having said that, if we look back three years, EPS growth has averaged a comparatively less impressive 7.6%.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
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 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.
So What Does Abbott Laboratories's Balance Sheet Tell Us?
Net debt totals 11% of Abbott Laboratories's market cap. That's enough debt to impact the P/E ratio a little; so keep it in mind if you're comparing it to companies without debt.
The Verdict On Abbott Laboratories's P/E Ratio
Abbott Laboratories's P/E is 49.9 which is above average (17.4) in its market. The company is not overly constrained by its modest debt levels, and its recent EPS growth is nothing short of stand-out. 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 Abbott Laboratories. 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).
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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.