This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll show how you can use Onto Innovation Inc.'s (NYSE:ONTO) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Onto Innovation's P/E ratio is 42.68. In other words, at today's prices, investors are paying $42.68 for every $1 in prior year profit.
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 Onto Innovation:
P/E of 42.68 = USD38.02 ÷ USD0.89 (Based on the year to September 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 Does Onto Innovation'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. As you can see below, Onto Innovation has a higher P/E than the average company (35.2) in the semiconductor industry.
That means that the market expects Onto Innovation will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. So further research is always essential. I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. That means unless the share price falls, the P/E will increase in a few years. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
Onto Innovation's earnings per share fell by 22% in the last twelve months. And over the longer term (3 years) earnings per share have decreased 6.4% annually. This might lead to low expectations.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
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).
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
So What Does Onto Innovation's Balance Sheet Tell Us?
The extra options and safety that comes with Onto Innovation's US$193m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Verdict On Onto Innovation's P/E Ratio
Onto Innovation has a P/E of 42.7. That's higher than the average in its market, which is 18.3. The recent drop in earnings per share might keep value investors away, but the healthy balance sheet means the company retains potential for future growth. If fails to eventuate, the current high P/E could prove to be temporary, as the share price falls.
Investors have an opportunity when market expectations about a stock are wrong. 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 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 Onto Innovation. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.
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