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Here’s How P/E Ratios Can Help Us Understand American Shared Hospital Services (NYSEMKT:AMS)

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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll look at American Shared Hospital Services’s (NYSEMKT:AMS) P/E ratio and reflect on what it tells us about the company’s share price. American Shared Hospital Services has a price to earnings ratio of 7.22, based on the last twelve months. That means that at current prices, buyers pay \$7.22 for every \$1 in trailing yearly profits.

How Do I Calculate A Price To Earnings Ratio?

The formula for P/E is:

Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)

Or for American Shared Hospital Services:

P/E of 7.22 = \$2.81 ÷ \$0.39 (Based on the trailing twelve months to September 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 isn’t a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business’s prospects, relative to stocks with a lower P/E.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. When earnings grow, the ‘E’ increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Notably, American Shared Hospital Services grew EPS by a whopping 132% in the last year. And its annual EPS growth rate over 5 years is 58%. With that performance, I would expect it to have an above average P/E ratio.

How Does American Shared Hospital Services’s P/E Ratio Compare To Its Peers?

The P/E ratio indicates whether the market has higher or lower expectations of a company. If you look at the image below, you can see American Shared Hospital Services has a lower P/E than the average (21.4) in the healthcare industry classification.

Its relatively low P/E ratio indicates that American Shared Hospital Services shareholders think it will struggle to do as well as other companies in its industry classification. 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.

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.

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).

American Shared Hospital Services’s Balance Sheet

Net debt totals a substantial 113% of American Shared Hospital Services’s market cap. 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 American Shared Hospital Services’s P/E Ratio

American Shared Hospital Services trades on a P/E ratio of 7.2, which is below the US market average of 17.7. The company has a meaningful amount of debt on the balance sheet, but that should not eclipse the solid earnings growth. If it continues to grow, then the current low P/E may prove to be unjustified.

When the market is wrong about a stock, it gives savvy investors an opportunity. 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.’ Although we don’t have analyst forecasts, shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.

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.

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 editorial-team@simplywallst.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.