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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll look at American Vanguard Corporation's (NYSE:AVD) P/E ratio and reflect on what it tells us about the company's share price. What is American Vanguard's P/E ratio? Well, based on the last twelve months it is 17.3. That corresponds to an earnings yield of approximately 5.8%.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for American Vanguard:
P/E of 17.3 = $13.87 ÷ $0.80 (Based on the year to March 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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.'
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
American Vanguard increased earnings per share by 8.9% last year. And earnings per share have improved by 2.9% annually, over the last five years.
How Does American Vanguard's P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. As you can see below American Vanguard has a P/E ratio that is fairly close for the average for the chemicals industry, which is 17.6.
That indicates that the market expects American Vanguard will perform roughly in line with other companies in its industry. So if American Vanguard actually outperforms its peers going forward, that should be a positive for the share price. I inform my view byby checking management tenure and remuneration, among other things.
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.
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 American Vanguard's Balance Sheet Tell Us?
American Vanguard has net debt equal to 35% of its market cap. While it's worth keeping this in mind, it isn't a worry.
The Verdict On American Vanguard's P/E Ratio
American Vanguard has a P/E of 17.3. That's around the same as the average in the US market, which is 17.6. With modest debt and some recent earnings growth, it seems likely the market expects a steady performance going forward.
When the market is wrong about a stock, it gives savvy investors an opportunity. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. 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.
But note: American Vanguard may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio 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.