This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll look at FactSet Research Systems Inc.'s (NYSE:FDS) P/E ratio and reflect on what it tells us about the company's share price. FactSet Research Systems has a P/E ratio of 22.92, based on the last twelve months. That is equivalent to an earnings yield of about 4.4%.
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 FactSet Research Systems:
P/E of 22.92 = $217.980 ÷ $9.510 (Based on the year to November 2019.)
(Note: the above calculation results may not be precise due to rounding.)
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 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 Does FactSet Research Systems's P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. As you can see below FactSet Research Systems has a P/E ratio that is fairly close for the average for the capital markets industry, which is 23.8.
FactSet Research Systems's P/E tells us that market participants think its prospects are roughly in line with its industry. So if FactSet Research Systems actually outperforms its peers going forward, that should be a positive for the share price. I would further inform my view by checking insider buying and selling., among other things.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. And in that case, the P/E ratio itself will drop rather quickly. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
FactSet Research Systems increased earnings per share by a whopping 30% last year. And earnings per share have improved by 13% annually, over the last five years. With that performance, I would expect it to have an above average P/E ratio.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. 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.
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.
Is Debt Impacting FactSet Research Systems's P/E?
FactSet Research Systems's net debt is 2.6% of its market cap. The market might award it a higher P/E ratio if it had net cash, but its unlikely this low level of net borrowing is having a big impact on the P/E multiple.
The Bottom Line On FactSet Research Systems's P/E Ratio
FactSet Research Systems has a P/E of 22.9. That's higher than the average in its market, which is 11.8. Its debt levels do not imperil its balance sheet and its EPS growth is very healthy indeed. So on this analysis a high P/E ratio seems reasonable.
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 visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
You might be able to find a better buy than FactSet Research Systems. 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 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.
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