This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll look at Olympic Steel, Inc.’s (NASDAQ:ZEUS) P/E ratio and reflect on what it tells us about the company’s share price. Olympic Steel has a price to earnings ratio of 5.24, based on the last twelve months. That is equivalent to an earnings yield of about 19%.
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 Olympic Steel:
P/E of 5.24 = $18.01 ÷ $3.44 (Based on the trailing twelve months to September 2018.)
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 necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. 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. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
Notably, Olympic Steel grew EPS by a whopping 208% in the last year. And it has bolstered its earnings per share by 40% per year over the last five years. So we’d generally expect it to have a relatively high P/E ratio.
How Does Olympic Steel’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. The image below shows that Olympic Steel has a lower P/E than the average (8.2) P/E for companies in the metals and mining industry.
This suggests that market participants think Olympic Steel will underperform other companies in its industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. 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
Don’t forget that the P/E ratio considers market capitalization. In other words, it does not consider any debt or cash that the company may have on the balance sheet. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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 Olympic Steel’s Debt Impact Its P/E Ratio?
Olympic Steel has net debt worth a very significant 155% of its market capitalization. This level of debt justifies a relatively low P/E, so remain cognizant of the debt, if you’re comparing it to other stocks.
The Bottom Line On Olympic Steel’s P/E Ratio
Olympic Steel trades on a P/E ratio of 5.2, which is below the US market average of 17.2. The company may have significant debt, but EPS growth was good last year. If it continues to grow, then the current low P/E may prove to be unjustified.
Investors should be looking to buy stocks that the market is wrong about. 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 report on the analyst consensus forecasts could help you make a master move on this stock.
You might be able to find a better buy than Olympic Steel. 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).
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.