The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we'll show how Phibro Animal Health Corporation's (NASDAQ:PAHC) P/E ratio could help you assess the value on offer. What is Phibro Animal Health's P/E ratio? Well, based on the last twelve months it is 15.81. That means that at current prices, buyers pay $15.81 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 Phibro Animal Health:
P/E of 15.81 = $21.4 ÷ $1.35 (Based on the trailing twelve months to June 2019.)
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.'
Does Phibro Animal Health Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. As you can see below Phibro Animal Health has a P/E ratio that is fairly close for the average for the pharmaceuticals industry, which is 16.2.
Its P/E ratio suggests that Phibro Animal Health shareholders think that in the future it will perform about the same as other companies in its industry classification. The company could surprise by performing better than average, in the future. I would further inform my view by checking insider buying and selling., among other things.
How Growth Rates Impact P/E Ratios
When earnings fall, the 'E' decreases, over time. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
Phibro Animal Health shrunk earnings per share by 16% over the last year. And it has shrunk its earnings per share by 14% per year over the last three years. This might lead to low expectations.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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.
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).
So What Does Phibro Animal Health's Balance Sheet Tell Us?
Phibro Animal Health's net debt equates to 28% of its market capitalization. While it's worth keeping this in mind, it isn't a worry.
The Verdict On Phibro Animal Health's P/E Ratio
Phibro Animal Health's P/E is 15.8 which is below average (18.2) in the US market. With only modest debt, it's likely the lack of EPS growth at least partially explains the pessimism implied by the P/E ratio.
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 report on the analyst consensus forecasts could help you make a master move on this stock.
But note: Phibro Animal Health 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).
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.