This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll show how you can use MKS Instruments Inc’s (NASDAQ:MKSI) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, MKS Instruments’s P/E ratio is 10.3. That is equivalent to an earnings yield of about 9.7%.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for MKS Instruments:
P/E of 10.3 = $75.44 ÷ $7.32 (Based on the trailing twelve months to September 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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
Probably the most important factor in determining what P/E a company trades on is the earnings growth. When earnings grow, the ‘E’ increases, over time. That means even if the current P/E is high, it will reduce over time if the share price stays flat. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Notably, MKS Instruments grew EPS by a whopping 29% in the last year. And earnings per share have improved by 40% annually, over the last five years. So we’d generally expect it to have a relatively high P/E ratio.
How Does MKS Instruments’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. The image below shows that MKS Instruments has a lower P/E than the average (18.9) P/E for companies in the semiconductor industry.
Its relatively low P/E ratio indicates that MKS Instruments shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with MKS Instruments, 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
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. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
MKS Instruments’s Balance Sheet
MKS Instruments has net cash of US$270m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Bottom Line On MKS Instruments’s P/E Ratio
MKS Instruments’s P/E is 10.3 which is below average (17.9) in the US market. The net cash position gives plenty of options to the business, and the recent improvement in EPS is good to see. One might conclude that the market is a bit pessimistic, given the low P/E ratio.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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 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 email@example.com.