This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll look at Xilinx, Inc.'s (NASDAQ:XLNX) P/E ratio and reflect on what it tells us about the company's share price. Based on the last twelve months, Xilinx's P/E ratio is 26.43. That means that at current prices, buyers pay $26.43 for every $1 in trailing yearly profits.
How Do I Calculate Xilinx's Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Xilinx:
P/E of 26.43 = $83.240 ÷ $3.149 (Based on the trailing twelve months to March 2020.)
(Note: the above calculation results may not be precise due to rounding.)
Is A High P/E Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. 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 Xilinx's P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. The image below shows that Xilinx has a lower P/E than the average (30.9) P/E for companies in the semiconductor industry.
Xilinx's P/E tells us that market participants think it will not fare as well as its peers in the same 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.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the 'E' increases, over time. And in that case, the P/E ratio itself will drop rather quickly. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Xilinx saw earnings per share decrease by 10% last year. But EPS is up 5.2% over the last 5 years.
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. Thus, the metric does not reflect cash or debt held by the company. 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.
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.
How Does Xilinx's Debt Impact Its P/E Ratio?
The extra options and safety that comes with Xilinx's US$1.1b 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 Xilinx's P/E Ratio
Xilinx has a P/E of 26.4. That's higher than the average in its market, which is 14.3. The recent drop in earnings per share might keep value investors away, but the relatively strong balance sheet will allow the company time to invest in growth. Clearly, the high P/E indicates shareholders think it will!
Investors have an opportunity when market expectations about a stock are wrong. 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 visual report on analyst forecasts could hold the key to an excellent investment decision.
You might be able to find a better buy than Xilinx. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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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