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Here's What Raven Industries, Inc.'s (NASDAQ:RAVN) P/E Is Telling Us

Simply Wall St

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Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll apply a basic P/E ratio analysis to Raven Industries, Inc.'s (NASDAQ:RAVN), to help you decide if the stock is worth further research. Raven Industries has a P/E ratio of 27.26, based on the last twelve months. That is equivalent to an earnings yield of about 3.7%.

View our latest analysis for Raven Industries

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 Raven Industries:

P/E of 27.26 = $39.21 ÷ $1.44 (Based on the trailing twelve months to January 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. 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.

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. That means even if the current P/E is high, it will reduce over time if the share price stays flat. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Notably, Raven Industries grew EPS by a whopping 26% in the last year. And earnings per share have improved by 4.1% annually, over the last five years. I'd therefore be a little surprised if its P/E ratio was not relatively high.

Does Raven Industries Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio essentially measures market expectations of a company. As you can see below, Raven Industries has a higher P/E than the average company (21.9) in the industrials industry.

NasdaqGS:RAVN Price Estimation Relative to Market, May 1st 2019
NasdaqGS:RAVN Price Estimation Relative to Market, May 1st 2019

Its relatively high P/E ratio indicates that Raven Industries shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. So investors 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

Don't forget that the P/E ratio considers market capitalization. In other words, it does not consider any debt or cash that the company may have on the balance sheet. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.

While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.

Raven Industries's Balance Sheet

Since Raven Industries holds net cash of US$66m, it can spend on growth, justifying a higher P/E ratio than otherwise.

The Bottom Line On Raven Industries's P/E Ratio

Raven Industries's P/E is 27.3 which is above average (18.3) in the US market. With cash in the bank the company has plenty of growth options -- and it is already on the right track. So it is not surprising the market is probably extrapolating recent growth well into the future, reflected in the relatively high P/E ratio.

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.

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 editorial-team@simplywallst.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.