Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. To keep it practical, we'll show how IRadimed Corporation's (NASDAQ:IRMD) P/E ratio could help you assess the value on offer. Looking at earnings over the last twelve months, IRadimed has a P/E ratio of 33.46. That is equivalent to an earnings yield of about 3.0%.
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How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for IRadimed:
P/E of 33.46 = $22.51 ÷ $0.67 (Based on the trailing twelve months to March 2019.)
Is A High Price-to-Earnings Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. 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 Growth Rates Impact P/E Ratios
When earnings fall, the 'E' decreases, over time. That means even if the current P/E is low, it will increase over time if the share price stays flat. Then, a higher P/E might scare off shareholders, pushing the share price down.
In the last year, IRadimed grew EPS like Taylor Swift grew her fan base back in 2010; the 353% gain was both fast and well deserved. The sweetener is that the annual five year growth rate of 21% is also impressive. So I'd be surprised if the P/E ratio was not above average. On the other hand, the longer term performance is poor, with EPS down -21% per year over 3 years.
How Does IRadimed's P/E Ratio Compare To Its Peers?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. We can see in the image below that the average P/E (38.8) for companies in the medical equipment industry is higher than IRadimed's P/E.
Its relatively low P/E ratio indicates that IRadimed shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
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. 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.
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).
So What Does IRadimed's Balance Sheet Tell Us?
IRadimed has net cash of US$32m. This is fairly high at 13% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.
The Verdict On IRadimed's P/E Ratio
IRadimed has a P/E of 33.5. That's higher than the average in the US market, which is 17.7. Its net cash position is the cherry on top of its superb EPS growth. So based on this analysis we'd expect IRadimed to have a high P/E ratio.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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 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 IRadimed. 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.