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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we'll show how Columbus McKinnon Corporation's (NASDAQ:CMCO) P/E ratio could help you assess the value on offer. Columbus McKinnon has a price to earnings ratio of 24.93, based on the last twelve months. That means that at current prices, buyers pay $24.93 for every $1 in trailing yearly profits.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Columbus McKinnon:
P/E of 24.93 = $33.65 ÷ $1.35 (Based on the trailing twelve months 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. That isn't necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the 'E' will be higher. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
It's nice to see that Columbus McKinnon grew EPS by a stonking 243% in the last year. And earnings per share have improved by 2.1% annually, over the last three years. I'd therefore be a little surprised if its P/E ratio was not relatively high. Unfortunately, earnings per share are down 23% a year, over 5 years.
How Does Columbus McKinnon's P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. As you can see below, Columbus McKinnon has a higher P/E than the average company (20.3) in the machinery industry.
Its relatively high P/E ratio indicates that Columbus McKinnon shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. So further research is always essential. I often monitor director buying and selling.
Remember: P/E Ratios Don't Consider The Balance Sheet
The 'Price' in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
Is Debt Impacting Columbus McKinnon's P/E?
Columbus McKinnon's net debt is 35% of its market cap. This is a reasonably significant level of debt -- all else being equal you'd expect a much lower P/E than if it had net cash.
The Verdict On Columbus McKinnon's P/E Ratio
Columbus McKinnon trades on a P/E ratio of 24.9, which is above the US market average of 17.3. The company is not overly constrained by its modest debt levels, and it is growing earnings per share. Therefore it seems reasonable that the market would have relatively high expectations of the company
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 report on the analyst consensus forecasts could help you make a master move on this stock.
Of course you might be able to find a better stock than Columbus McKinnon. So you may wish to see this free collection of other companies that have grown earnings strongly.
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 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.