This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll look at PetMed Express, Inc.’s (NASDAQ:PETS) P/E ratio and reflect on what it tells us about the company’s share price. PetMed Express has a P/E ratio of 11.2, based on the last twelve months. That corresponds to an earnings yield of approximately 8.9%.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for PetMed Express:
P/E of 11.2 = $22.65 ÷ $2.02 (Based on the year to December 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
P/E ratios primarily reflect market expectations around earnings growth rates. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
It’s great to see that PetMed Express grew EPS by 19% in the last year. And its annual EPS growth rate over 5 years is 20%. With that performance, you might expect an above average P/E ratio.
How Does PetMed Express’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. We can see in the image below that the average P/E (34.5) for companies in the online retail industry is higher than PetMed Express’s P/E.
This suggests that market participants think PetMed Express will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. You should delve deeper. I like to check if company insiders have been buying or selling.
Remember: P/E Ratios Don’t Consider The Balance Sheet
The ‘Price’ in P/E reflects the market capitalization of the company. That means it doesn’t take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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).
PetMed Express’s Balance Sheet
The extra options and safety that comes with PetMed Express’s US$93m 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 PetMed Express’s P/E Ratio
PetMed Express trades on a P/E ratio of 11.2, which is below the US market average of 16.7. It grew its EPS nicely over the last year, and the healthy balance sheet implies there is more potential for growth. The relatively low P/E ratio implies the market is pessimistic.
Investors should be looking to buy stocks that the market is wrong about. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. 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 be able to find a better stock than PetMed Express. 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 firstname.lastname@example.org.