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 Allegheny Technologies Incorporated's (NYSE:ATI) P/E ratio could help you assess the value on offer. Looking at earnings over the last twelve months, Allegheny Technologies has a P/E ratio of 10.89. That is equivalent to an earnings yield of about 9.2%.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Allegheny Technologies:
P/E of 10.89 = $20.99 ÷ $1.93 (Based on the year to September 2019.)
Is A High Price-to-Earnings 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. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price'.
Does Allegheny Technologies 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. The image below shows that Allegheny Technologies has a lower P/E than the average (12.1) P/E for companies in the metals and mining industry.
This suggests that market participants think Allegheny Technologies will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. You should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. Earnings growth means that in the future the 'E' will be higher. And in that case, the P/E ratio itself will drop rather quickly. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Notably, Allegheny Technologies grew EPS by a whopping 30% in the last year.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
The 'Price' in P/E reflects the market capitalization of the company. That means it doesn't take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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).
Is Debt Impacting Allegheny Technologies's P/E?
Allegheny Technologies has net debt equal to 39% of its market cap. While that's enough to warrant consideration, it doesn't really concern us.
The Bottom Line On Allegheny Technologies's P/E Ratio
Allegheny Technologies has a P/E of 10.9. That's below the average in the US market, which is 18.9. The company does have a little debt, and EPS growth was good last year. If the company can continue to grow earnings, then the current P/E may be unjustifiably low.
Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. 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 Allegheny Technologies. 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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