Here's What Watts Water Technologies, Inc.'s (NYSE:WTS) P/E Is Telling Us
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Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll show how you can use Watts Water Technologies, Inc.'s (NYSE:WTS) P/E ratio to inform your assessment of the investment opportunity. Watts Water Technologies has a price to earnings ratio of 22.34, based on the last twelve months. That means that at current prices, buyers pay $22.34 for every $1 in trailing yearly profits.
Check out our latest analysis for Watts Water Technologies
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Watts Water Technologies:
P/E of 22.34 = $83.38 ÷ $3.73 (Based on the year to December 2018.)
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.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. Earnings growth means that in the future the 'E' will be higher. 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.
Watts Water Technologies's 76% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. The cherry on top is that the five year growth rate was an impressive 17% per year. With that kind of growth rate we would generally expect a high P/E ratio.
How Does Watts Water Technologies's P/E Ratio Compare To Its Peers?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. You can see in the image below that the average P/E (21.1) for companies in the machinery industry is roughly the same as Watts Water Technologies's P/E.
Its P/E ratio suggests that Watts Water Technologies shareholders think that in the future it will perform about the same as other companies in its industry classification. So if Watts Water Technologies 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
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
Watts Water Technologies's Balance Sheet
Watts Water Technologies's net debt is 5.3% 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 Bottom Line On Watts Water Technologies's P/E Ratio
Watts Water Technologies trades on a P/E ratio of 22.3, which is above the US market average of 18.1. The company is not overly constrained by its modest debt levels, and its recent EPS growth is nothing short of stand-out. So on this analysis a high P/E ratio seems reasonable.
Investors should be looking to buy stocks that the market is wrong about. 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.
But note: Watts Water Technologies 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).
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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.
