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 Methode Electronics, Inc.'s (NYSE:MEI) P/E ratio to inform your assessment of the investment opportunity. What is Methode Electronics's P/E ratio? Well, based on the last twelve months it is 14.03. That means that at current prices, buyers pay $14.03 for every $1 in trailing yearly profits.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Methode Electronics:
P/E of 14.03 = $39.45 ÷ $2.81 (Based on the trailing twelve months to October 2019.)
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 Does Methode Electronics'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. The image below shows that Methode Electronics has a lower P/E than the average (21.3) P/E for companies in the electronic industry.
Methode Electronics's P/E tells us that market participants think it will not fare as well as its peers in the same industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
In the last year, Methode Electronics grew EPS like Taylor Swift grew her fan base back in 2010; the 106% gain was both fast and well deserved. Having said that, if we look back three years, EPS growth has averaged a comparatively less impressive 7.2%.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. In other words, it does not consider any debt or cash that the company may have on the balance sheet. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.
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).
Methode Electronics's Balance Sheet
Net debt totals 12% of Methode Electronics'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 Methode Electronics's P/E Ratio
Methode Electronics has a P/E of 14.0. That's below the average in the US market, which is 18.9. The company hasn't stretched its balance sheet, and earnings growth was good last year. If it continues to grow, then the current low P/E may prove to be unjustified. Because analysts are predicting more growth in the future, one might have expected to see a higher P/E ratio. You can take a closer look at the fundamentals, here.
When the market is wrong about a stock, it gives savvy investors an opportunity. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
But note: Methode Electronics 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).
If you spot an error that warrants correction, please contact the editor at email@example.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.
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