Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll show how you can use Fisher & Paykel Healthcare Corporation Limited's (NZSE:FPH) P/E ratio to inform your assessment of the investment opportunity. Fisher & Paykel Healthcare has a price to earnings ratio of 46.19, based on the last twelve months. That means that at current prices, buyers pay NZ$46.19 for every NZ$1 in trailing yearly profits.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Fisher & Paykel Healthcare:
P/E of 46.19 = NZ$16.87 ÷ NZ$0.37 (Based on the year to March 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each NZ$1 of company earnings. 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.
Does Fisher & Paykel Healthcare 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. You can see in the image below that the average P/E (36.6) for companies in the medical equipment industry is lower than Fisher & Paykel Healthcare's P/E.
Its relatively high P/E ratio indicates that Fisher & Paykel Healthcare shareholders think it will perform better than other companies in its industry classification. 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.
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. Earnings growth means that in the future the 'E' will be higher. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.
Fisher & Paykel Healthcare saw earnings per share improve by -9.5% last year. And it has bolstered its earnings per share by 16% per year over the last five years.
Remember: P/E Ratios Don't Consider The Balance Sheet
Don't forget that the P/E ratio considers market capitalization. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).
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.
Is Debt Impacting Fisher & Paykel Healthcare's P/E?
Fisher & Paykel Healthcare has net cash of NZ$54m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Bottom Line On Fisher & Paykel Healthcare's P/E Ratio
Fisher & Paykel Healthcare has a P/E of 46.2. That's higher than the average in its market, which is 18.5. Recent earnings growth wasn't bad. And the healthy balance sheet means the company can sustain growth while the P/E suggests shareholders think it will.
Investors should be looking to buy stocks that the market is wrong about. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
Of course you might be able to find a better stock than Fisher & Paykel Healthcare. 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 firstname.lastname@example.org. 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.