Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at Grand Canyon Education, Inc.'s (NASDAQ:LOPE) P/E ratio and reflect on what it tells us about the company's share price. Looking at earnings over the last twelve months, Grand Canyon Education has a P/E ratio of 17.74. That means that at current prices, buyers pay $17.74 for every $1 in trailing yearly profits.
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Grand Canyon Education:
P/E of 17.74 = $95.79 ÷ $5.40 (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. That isn't necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
Does Grand Canyon Education Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. We can see in the image below that the average P/E (28.2) for companies in the consumer services industry is higher than Grand Canyon Education's P/E.
Its relatively low P/E ratio indicates that Grand Canyon Education shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Grand Canyon Education, 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
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. And in that case, the P/E ratio itself will drop rather quickly. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
It's great to see that Grand Canyon Education grew EPS by 16% in the last year. And its annual EPS growth rate over 5 years is 19%. So one might expect an above average P/E ratio.
Remember: P/E Ratios Don't Consider The Balance Sheet
Don't forget that the P/E ratio considers market capitalization. That means it doesn't take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
So What Does Grand Canyon Education's Balance Sheet Tell Us?
Grand Canyon Education's net debt is 2.7% of its market cap. It would probably trade on a higher P/E ratio if it had a lot of cash, but I doubt it is having a big impact.
The Verdict On Grand Canyon Education's P/E Ratio
Grand Canyon Education's P/E is 17.7 which is about average (18.9) in the US market. With only modest debt levels, and strong earnings growth, the market seems to doubt that the growth can be maintained.
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.
You might be able to find a better buy than Grand Canyon Education. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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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