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Read This Before You Buy Accenture plc (NYSE:ACN) Because Of Its P/E Ratio

Simply Wall St

Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at Accenture plc's (NYSE:ACN) P/E ratio and reflect on what it tells us about the company's share price. Based on the last twelve months, Accenture's P/E ratio is 26.87. That corresponds to an earnings yield of approximately 3.7%.

View our latest analysis for Accenture

How Do You Calculate Accenture's P/E Ratio?

The formula for P/E is:

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

Or for Accenture:

P/E of 26.87 = $201.25 ÷ $7.49 (Based on the trailing twelve months to August 2019.)

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.

Does Accenture Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that Accenture has a lower P/E than the average (31.3) P/E for companies in the it industry.

NYSE:ACN Price Estimation Relative to Market, November 30th 2019

Its relatively low P/E ratio indicates that Accenture shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Accenture, it's quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.

How Growth Rates Impact P/E Ratios

Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. That means even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

Most would be impressed by Accenture earnings growth of 16% in the last year. And it has bolstered its earnings per share by 10% per year over the last five years. With that performance, you might expect an above average P/E ratio.

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. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.

How Does Accenture's Debt Impact Its P/E Ratio?

Since Accenture holds net cash of US$6.1b, it can spend on growth, justifying a higher P/E ratio than otherwise.

The Verdict On Accenture's P/E Ratio

Accenture's P/E is 26.9 which is above average (18.4) in its market. With cash in the bank the company has plenty of growth options -- and it is already on the right track. Therefore it seems reasonable that the market would have relatively high expectations of the company

Investors have an opportunity when market expectations about a stock are wrong. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

Of course you might be able to find a better stock than Accenture. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.

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. Thank you for reading.