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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 Polaris Industries Inc.'s (NYSE:PII) P/E ratio could help you assess the value on offer. What is Polaris Industries's P/E ratio? Well, based on the last twelve months it is 17.01. That corresponds to an earnings yield of approximately 5.9%.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Polaris Industries:
P/E of 17.01 = $91.23 ÷ $5.36 (Based on the trailing twelve months to December 2018.)
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.
How Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. That means unless the share price falls, the P/E will increase in a few years. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
In the last year, Polaris Industries grew EPS like Taylor Swift grew her fan base back in 2010; the 96% gain was both fast and well deserved. On the other hand, the longer term performance is poor, with EPS down 0.7% per year over 3 years.
How Does Polaris Industries's P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. As you can see below Polaris Industries has a P/E ratio that is fairly close for the average for the leisure industry, which is 16.9.
Its P/E ratio suggests that Polaris Industries shareholders think that in the future it will perform about the same as other companies in its industry classification. The company could surprise by performing better than average, in the future. Checking factors such as the tenure of the board and management could help you form your own view on if that will happen.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don't forget that the P/E ratio considers market capitalization. So it won't reflect the advantage of cash, or disadvantage of debt. 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 Polaris Industries's Balance Sheet Tell Us?
Polaris Industries's net debt equates to 32% of its market capitalization. While it's worth keeping this in mind, it isn't a worry.
The Bottom Line On Polaris Industries's P/E Ratio
Polaris Industries trades on a P/E ratio of 17, which is fairly close to the US market average of 18.1. 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 visual report on analyst forecasts could hold the key to an excellent investment decision.
Of course you might be able to find a better stock than Polaris Industries. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.