The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we'll show how KBR, Inc.'s (NYSE:KBR) P/E ratio could help you assess the value on offer. Looking at earnings over the last twelve months, KBR has a P/E ratio of 19.11. That corresponds to an earnings yield of approximately 5.2%.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for KBR:
P/E of 19.11 = $25.52 ÷ $1.34 (Based on the trailing twelve months to June 2019.)
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 a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.
Does KBR Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio indicates whether the market has higher or lower expectations of a company. If you look at the image below, you can see KBR has a lower P/E than the average (34.6) in the it industry classification.
Its relatively low P/E ratio indicates that KBR 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. You should delve deeper. I like to check if company insiders have been buying or selling.
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 unless the share price increases, the P/E will reduce in a few years. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
KBR shrunk earnings per share by 62% over the last year. But EPS is up 1.1% over the last 3 years.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
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.
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.
KBR's Balance Sheet
KBR's net debt is 17% of its market cap. This could bring some additional risk, and reduce the number of investment options for management; worth remembering if you compare its P/E to businesses without debt.
The Bottom Line On KBR's P/E Ratio
KBR trades on a P/E ratio of 19.1, which is above its market average of 17.3. With modest debt but no EPS growth in the last year, it's fair to say the P/E implies some optimism about future earnings, from the market.
Investors should be looking to buy stocks that the market is wrong about. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine.' So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
Of course you might be able to find a better stock than KBR. 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.