The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll look at Park-Ohio Holdings Corp.’s (NASDAQ:PKOH) P/E ratio and reflect on what it tells us about the company’s share price. Park-Ohio Holdings has a P/E ratio of 8.64, based on the last twelve months. That corresponds to an earnings yield of approximately 12%.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Park-Ohio Holdings:
P/E of 8.64 = $31.37 ÷ $3.63 (Based on the year to September 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each $1 the company has earned over the last year. 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
When earnings fall, the ‘E’ decreases, over time. That means even if the current P/E is low, it will increase over time if the share price stays flat. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
Notably, Park-Ohio Holdings grew EPS by a whopping 51% in the last year. In contrast, EPS has decreased by 5.4%, annually, over 5 years.
How Does Park-Ohio Holdings’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. The image below shows that Park-Ohio Holdings has a lower P/E than the average (18.2) P/E for companies in the machinery industry.
Its relatively low P/E ratio indicates that Park-Ohio Holdings shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Park-Ohio Holdings, 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.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
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. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
Is Debt Impacting Park-Ohio Holdings’s P/E?
Park-Ohio Holdings’s net debt is considerable, at 135% of its market cap. If you want to compare its P/E ratio to other companies, you must keep in mind that these debt levels would usually warrant a relatively low P/E.
The Bottom Line On Park-Ohio Holdings’s P/E Ratio
Park-Ohio Holdings trades on a P/E ratio of 8.6, which is below the US market average of 16.8. While the EPS growth last year was strong, the significant debt levels reduce the number of options available to management. 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. 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.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
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 firstname.lastname@example.org.