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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll look at FONAR Corporation's (NASDAQ:FONR) P/E ratio and reflect on what it tells us about the company's share price. FONAR has a P/E ratio of 7.13, based on the last twelve months. That corresponds to an earnings yield of approximately 14%.
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for FONAR:
P/E of 7.13 = $20.94 ÷ $2.94 (Based on the trailing twelve months to December 2018.)
Is A High P/E Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.'
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. When earnings grow, the 'E' increases, over time. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.
FONAR's earnings per share were pretty steady over the last year. But it has grown its earnings per share by 14% per year over the last five years.
How Does FONAR's P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that FONAR has a lower P/E than the average (39.8) P/E for companies in the medical equipment industry.
Its relatively low P/E ratio indicates that FONAR shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with FONAR, it's quite possible it could surprise on the upside. You 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. That means it doesn't take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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.
FONAR's Balance Sheet
The extra options and safety that comes with FONAR's US$23m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Verdict On FONAR's P/E Ratio
FONAR trades on a P/E ratio of 7.1, which is below the US market average of 17.7. EPS was up modestly better over the last twelve months. And the healthy balance sheet means the company can sustain growth while the P/E suggests shareholders don't think it will.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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.' Although we don't have analyst forecasts, shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
But note: FONAR 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).
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.