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 Agilent Technologies, Inc.’s (NYSE:A) P/E ratio could help you assess the value on offer. Agilent Technologies has a P/E ratio of 22.48, based on the last twelve months. That corresponds to an earnings yield of approximately 4.4%.
How Do You Calculate Agilent Technologies’s P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Agilent Technologies:
P/E of 22.48 = $80.13 ÷ $3.57 (Based on the year to January 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.
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. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.
Agilent Technologies increased earnings per share by a whopping 486% last year. And it has bolstered its earnings per share by 7.6% per year over the last five years. So we’d generally expect it to have a relatively high P/E ratio.
How Does Agilent Technologies’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. We can see in the image below that the average P/E (34.7) for companies in the life sciences industry is higher than Agilent Technologies’s P/E.
Its relatively low P/E ratio indicates that Agilent Technologies shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Agilent Technologies, 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.
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. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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).
Is Debt Impacting Agilent Technologies’s P/E?
The extra options and safety that comes with Agilent Technologies’s US$259m 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 Agilent Technologies’s P/E Ratio
Agilent Technologies has a P/E of 22.5. That’s higher than the average in the US market, which is 17.6. Its strong balance sheet gives the company plenty of resources for extra growth, and it has already proven it can grow. So it is not surprising the market is probably extrapolating recent growth well into the future, reflected in the relatively high P/E ratio.
Investors should be looking to buy stocks that the market is wrong about. 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 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.
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If you spot an error that warrants correction, please contact the editor at email@example.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.