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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we’ll show how Barrett Business Services, Inc.’s (NASDAQ:BBSI) P/E ratio could help you assess the value on offer. Barrett Business Services has a price to earnings ratio of 14.5, based on the last twelve months. In other words, at today’s prices, investors are paying $14.5 for every $1 in prior year profit.
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 Barrett Business Services:
P/E of 14.5 = $62.79 ÷ $4.33 (Based on the year to September 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each $1 the company has earned over the last year. 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
P/E ratios primarily reflect market expectations around earnings growth rates. 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.
It’s nice to see that Barrett Business Services grew EPS by a stonking 38% in the last year. And earnings per share have improved by 27% annually, over the last five years. So we’d generally expect it to have a relatively high P/E ratio.
How Does Barrett Business Services’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. If you look at the image below, you can see Barrett Business Services has a lower P/E than the average (23.9) in the professional services industry classification.
This suggests that market participants think Barrett Business Services will underperform other companies in its industry. Since the market seems unimpressed with Barrett Business Services, 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.
Remember: P/E Ratios Don’t Consider The Balance Sheet
The ‘Price’ in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. 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 Barrett Business Services’s Debt Impact Its P/E Ratio?
The extra options and safety that comes with Barrett Business Services’s US$31m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Bottom Line On Barrett Business Services’s P/E Ratio
Barrett Business Services has a P/E of 14.5. That’s below the average in the US market, which is 16.7. 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. Since analysts are predicting growth will continue, one might expect to see a higher P/E so it may be worth looking closer.
Investors have an opportunity when market expectations about a stock are wrong. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free visual report on analyst forecasts could hold they key to an excellent investment decision.
But note: Barrett Business Services 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).
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.