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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll look at DICK'S Sporting Goods, Inc.'s (NYSE:DKS) P/E ratio and reflect on what it tells us about the company's share price. DICK'S Sporting Goods has a P/E ratio of 11.14, based on the last twelve months. In other words, at today's prices, investors are paying $11.14 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 = Price per Share ÷ Earnings per Share (EPS)
Or for DICK'S Sporting Goods:
P/E of 11.14 = $36.47 ÷ $3.27 (Based on the year to February 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.'
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. Earnings growth means that in the future the 'E' will be higher. That means even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
DICK'S Sporting Goods saw earnings per share improve by -8.3% last year. And its annual EPS growth rate over 5 years is 3.6%.
How Does DICK'S Sporting Goods's P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. We can see in the image below that the average P/E (16.3) for companies in the specialty retail industry is higher than DICK'S Sporting Goods's P/E.
This suggests that market participants think DICK'S Sporting Goods 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.
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. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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 DICK'S Sporting Goods's Balance Sheet Tell Us?
DICK'S Sporting Goods has net cash of US$54m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Verdict On DICK'S Sporting Goods's P/E Ratio
DICK'S Sporting Goods's P/E is 11.1 which is below average (18.4) in the US market. Recent earnings growth wasn't bad. Also positive, the relatively strong balance sheet will allow for investment in growth. In contrast, the P/E indicates shareholders doubt that will happen!
Investors have an opportunity when market expectations about a stock are wrong. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. 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.