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 Regal Beloit Corporation's (NYSE:RBC) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Regal Beloit's P/E ratio is 13.71. That means that at current prices, buyers pay $13.71 for every $1 in trailing yearly profits.
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 Regal Beloit:
P/E of 13.71 = $83.22 ÷ $6.07 (Based on the trailing twelve months to September 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each $1 of company 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.
Does Regal Beloit Have A Relatively High Or Low P/E For Its Industry?
We can get an indication of market expectations by looking at the P/E ratio. If you look at the image below, you can see Regal Beloit has a lower P/E than the average (16.9) in the electrical industry classification.
This suggests that market participants think Regal Beloit will underperform other companies in its industry. Since the market seems unimpressed with Regal Beloit, it's quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. That means unless the share price increases, the P/E will reduce in a few years. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Regal Beloit increased earnings per share by an impressive 17% over the last twelve months. And it has bolstered its earnings per share by 19% per year over the last five years. This could arguably justify a relatively high P/E ratio.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. Thus, the metric does not reflect cash or debt held by the company. 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.
How Does Regal Beloit's Debt Impact Its P/E Ratio?
Regal Beloit has net debt worth 24% of its market capitalization. That's enough debt to impact the P/E ratio a little; so keep it in mind if you're comparing it to companies without debt.
The Verdict On Regal Beloit's P/E Ratio
Regal Beloit trades on a P/E ratio of 13.7, which is below the US market average of 18.3. The company does have a little debt, and EPS growth was good last year. If it continues to grow, then the current low P/E may prove to be unjustified.
Investors should be looking to buy stocks that the market is wrong about. 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 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 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.