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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll show how you can use Photronics, Inc.’s (NASDAQ:PLAB) P/E ratio to inform your assessment of the investment opportunity. Photronics has a P/E ratio of 17.63, based on the last twelve months. In other words, at today’s prices, investors are paying $17.63 for every $1 in prior year profit.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Photronics:
P/E of 17.63 = $10.77 ÷ $0.61 (Based on the trailing twelve months to October 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 is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
How Growth Rates Impact P/E Ratios
When earnings fall, the ‘E’ decreases, over time. That means unless the share price falls, the P/E will increase in a few years. Then, a higher P/E might scare off shareholders, pushing the share price down.
Notably, Photronics grew EPS by a whopping 216% in the last year. Unfortunately, earnings per share are down 33% a year, over 3 years.
How Does Photronics’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. You can see in the image below that the average P/E (16) for companies in the semiconductor industry is lower than Photronics’s P/E.
Photronics’s P/E tells us that market participants think the company will perform better than its industry peers, going forward. Shareholders are clearly optimistic, but the future is always uncertain. So investors 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
Don’t forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. Theoretically, a business can improve its earnings (and produce a lower P/E in the future), by taking on debt (or spending its remaining cash).
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.
Is Debt Impacting Photronics’s P/E?
Since Photronics holds net cash of US$272m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Bottom Line On Photronics’s P/E Ratio
Photronics has a P/E of 17.6. That’s around the same as the average in the US market, which is 16.8. With a strong balance sheet combined with recent growth, the P/E implies the market is quite pessimistic.
Investors have an opportunity when market expectations about a stock are wrong. 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 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 be able to find a better stock than Photronics. So you may wish to see this free collection of other companies that have grown earnings strongly.
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 firstname.lastname@example.org.