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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 show how you can use McGrath RentCorp’s (NASDAQ:MGRC) P/E ratio to inform your assessment of the investment opportunity. McGrath RentCorp has a price to earnings ratio of 6.99, based on the last twelve months. That is equivalent to an earnings yield of about 14%.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for McGrath RentCorp:
P/E of 6.99 = $50.13 ÷ $7.17 (Based on the year to September 2018.)
Is A High Price-to-Earnings 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 Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. 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. Then, a lower P/E should attract more buyers, pushing the share price up.
Notably, McGrath RentCorp grew EPS by a whopping 274% in the last year. And earnings per share have improved by 34% annually, over the last five years. I’d therefore be a little surprised if its P/E ratio was not relatively high.
How Does McGrath RentCorp’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. If you look at the image below, you can see McGrath RentCorp has a lower P/E than the average (19.1) in the commercial services industry classification.
Its relatively low P/E ratio indicates that McGrath RentCorp shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with McGrath RentCorp, it’s quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
The ‘Price’ in P/E reflects the market capitalization of the company. 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 taking on debt (or spending its remaining 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.
McGrath RentCorp’s Balance Sheet
McGrath RentCorp has net debt worth 25% of its market capitalization. This is a reasonably significant level of debt — all else being equal you’d expect a much lower P/E than if it had net cash.
The Verdict On McGrath RentCorp’s P/E Ratio
McGrath RentCorp trades on a P/E ratio of 7, which is below the US market average of 16.8. The company hasn’t stretched its balance sheet, and earnings growth was good last year. If the company can continue to grow earnings, then the current P/E may be unjustifiably low.
Investors should be looking to buy stocks that the market is wrong about. 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 report on the analyst consensus forecasts could help you make a master move on this stock.
Of course you might be able to find a better stock than McGrath RentCorp. So you may wish to see this free collection of other companies that have grown earnings strongly.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.