Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!
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 Skyworks Solutions, Inc.'s (NASDAQ:SWKS) P/E ratio to inform your assessment of the investment opportunity. Looking at earnings over the last twelve months, Skyworks Solutions has a P/E ratio of 14.4. In other words, at today's prices, investors are paying $14.4 for every $1 in prior year profit.
How Do You Calculate Skyworks Solutions's P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Skyworks Solutions:
P/E of 14.4 = $90.79 ÷ $6.31 (Based on the trailing twelve months to December 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 is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
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. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.
Notably, Skyworks Solutions grew EPS by a whopping 41% in the last year. And its annual EPS growth rate over 5 years is 31%. I'd therefore be a little surprised if its P/E ratio was not relatively high.
How Does Skyworks Solutions's P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. We can see in the image below that the average P/E (21.3) for companies in the semiconductor industry is higher than Skyworks Solutions's P/E.
This suggests that market participants think Skyworks Solutions will underperform other companies in its industry. Since the market seems unimpressed with Skyworks Solutions, 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
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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).
Skyworks Solutions's Balance Sheet
Since Skyworks Solutions holds net cash of US$1.1b, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Verdict On Skyworks Solutions's P/E Ratio
Skyworks Solutions trades on a P/E ratio of 14.4, which is below the US market average of 18.1. 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 have an opportunity when market expectations about a stock are wrong. 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 visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
But note: Skyworks Solutions 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).
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 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. Thank you for reading.