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Here's What Applied Materials, Inc.'s (NASDAQ:AMAT) P/E Ratio Is Telling Us

This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll show how you can use Applied Materials, Inc.'s (NASDAQ:AMAT) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Applied Materials's P/E ratio is 14.8. That corresponds to an earnings yield of approximately 6.8%.

Check out our latest analysis for Applied Materials

How Do I Calculate Applied Materials's Price To Earnings Ratio?

The formula for price to earnings is:

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

Or for Applied Materials:

P/E of 14.8 = $47.31 ÷ $3.2 (Based on the trailing twelve months to July 2019.)

Is A High P/E 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.'

Does Applied Materials 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. If you look at the image below, you can see Applied Materials has a lower P/E than the average (27.8) in the semiconductor industry classification.

NasdaqGS:AMAT Price Estimation Relative to Market, August 30th 2019
NasdaqGS:AMAT Price Estimation Relative to Market, August 30th 2019

Applied Materials's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Applied Materials, it's quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.

How Growth Rates Impact P/E Ratios

Probably the most important factor in determining what P/E a company trades on is the earnings growth. 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. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

Applied Materials had pretty flat EPS growth in the last year. But EPS is up 31% over the last 5 years.

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

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. In other words, it does not consider any debt or cash that the company may have on the balance sheet. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.

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.

Applied Materials's Balance Sheet

Applied Materials has net debt worth just 4.0% of its market capitalization. So it doesn't have as many options as it would with net cash, but its debt would not have much of an impact on its P/E ratio.

The Bottom Line On Applied Materials's P/E Ratio

Applied Materials trades on a P/E ratio of 14.8, which is below the US market average of 17.3. The company hasn't stretched its balance sheet, and earnings are improving. If growth is sustainable over the long term, then the current P/E ratio may be a sign of good value.

Investors should be looking to buy stocks that the market is wrong about. 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 the key to an excellent investment decision.

You might be able to find a better buy than Applied Materials. 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.

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