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Is Kaiser Aluminum Corporation's (NASDAQ:KALU) High P/E Ratio A Problem For Investors?

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 show how you can use Kaiser Aluminum Corporation's (NASDAQ:KALU) P/E ratio to inform your assessment of the investment opportunity. Kaiser Aluminum has a price to earnings ratio of 16.69, based on the last twelve months. That corresponds to an earnings yield of approximately 6.0%.

Check out our latest analysis for Kaiser Aluminum

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 Kaiser Aluminum:

P/E of 16.69 = $95.47 ÷ $5.72 (Based on the year to March 2019.)

Is A High Price-to-Earnings Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing 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.

Does Kaiser Aluminum Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that Kaiser Aluminum has a higher P/E than the average (10.8) P/E for companies in the metals and mining industry.

NasdaqGS:KALU Price Estimation Relative to Market, July 18th 2019

Kaiser Aluminum's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Clearly the market expects growth, but it isn't guaranteed. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

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. When earnings grow, the 'E' increases, over time. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

Kaiser Aluminum's earnings made like a rocket, taking off 174% last year. Having said that, the average EPS growth over the last three years wasn't so good, coming in at 6.6%.

Remember: P/E Ratios Don't Consider The Balance Sheet

Don't forget that the P/E ratio considers market capitalization. So it won't reflect the advantage of cash, or disadvantage of debt. 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).

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.

How Does Kaiser Aluminum's Debt Impact Its P/E Ratio?

Net debt totals 16% of Kaiser Aluminum's market cap. This could bring some additional risk, and reduce the number of investment options for management; worth remembering if you compare its P/E to businesses without debt.

The Verdict On Kaiser Aluminum's P/E Ratio

Kaiser Aluminum has a P/E of 16.7. That's around the same as the average in the US market, which is 17.9. With only modest debt levels, and strong earnings growth, the market seems to doubt that the growth can be maintained. Because analysts are predicting more growth in the future, one might have expected to see a higher P/E ratio. You can taker closer look at the fundamentals, here.

When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.

Of course you might be able to find a better stock than Kaiser Aluminum. 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 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.