This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to Mastercard Incorporated's (NYSE:MA), to help you decide if the stock is worth further research. What is Mastercard's P/E ratio? Well, based on the last twelve months it is 41.95. That means that at current prices, buyers pay $41.95 for every $1 in trailing yearly profits.
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How Do You Calculate Mastercard's P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Mastercard:
P/E of 41.95 = $252.55 ÷ $6.02 (Based on the year to March 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. 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
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.
Mastercard increased earnings per share by a whopping 48% last year. And earnings per share have improved by 18% annually, over the last five years. So we'd generally expect it to have a relatively high P/E ratio.
Does Mastercard 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. You can see in the image below that the average P/E (30.9) for companies in the it industry is lower than Mastercard's P/E.
Its relatively high P/E ratio indicates that Mastercard shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn't guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
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.
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.
So What Does Mastercard's Balance Sheet Tell Us?
The extra options and safety that comes with Mastercard's US$469m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Bottom Line On Mastercard's P/E Ratio
Mastercard trades on a P/E ratio of 42, which is above the US market average of 17.7. The excess cash it carries is the gravy on top its fast EPS growth. So based on this analysis we'd expect Mastercard to have a high P/E ratio.
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 find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
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.