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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll show how you can use PGT Innovations, Inc.'s (NYSE:PGTI) P/E ratio to inform your assessment of the investment opportunity. What is Innovations's P/E ratio? Well, based on the last twelve months it is 15.67. That is equivalent to an earnings yield of about 6.4%.
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 Innovations:
P/E of 15.67 = $15.76 ÷ $1.01 (Based on the year to March 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. That isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.
It's great to see that Innovations grew EPS by 13% in the last year. And it has bolstered its earnings per share by 14% per year over the last five years. This could arguably justify a relatively high P/E ratio.
How Does Innovations's P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that Innovations has a lower P/E than the average (17.9) P/E for companies in the building industry.
Its relatively low P/E ratio indicates that Innovations shareholders think it will struggle to do as well as other companies in its industry classification. 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.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. Thus, the metric does not reflect cash or debt held by the company. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).
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.
Innovations's Balance Sheet
Innovations's net debt equates to 35% of its market capitalization. You'd want to be aware of this fact, but it doesn't bother us.
The Bottom Line On Innovations's P/E Ratio
Innovations trades on a P/E ratio of 15.7, which is below the US market average of 17.6. The EPS growth last year was strong, and debt levels are quite reasonable. If the company can continue to grow earnings, then the current P/E may be unjustifiably low. Given analysts are expecting further growth, one might have expected a higher P/E ratio. That may be worth further research.
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.' 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 Innovations. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.