The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll show how you can use Utah Medical Products Inc’s (NASDAQ:UTMD) P/E ratio to inform your assessment of the investment opportunity. Utah Medical Products has a P/E ratio of 27.73, based on the last twelve months. That is equivalent to an earnings yield of about 3.6%.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Utah Medical Products:
P/E of 27.73 = $94 ÷ $3.39 (Based on the trailing twelve months to September 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each $1 the company has earned over the last year. 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
If earnings fall then in the future the ‘E’ will be lower. That means unless the share price falls, the P/E will increase in a few years. A higher P/E should indicate the stock is expensive relative to others — and that may encourage shareholders to sell.
Utah Medical Products’s earnings per share fell by 8.2% in the last twelve months. And EPS is down 5.0% a year, over the last 3 years. So we might expect a relatively low P/E.
How Does Utah Medical Products’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Utah Medical Products has a lower P/E than the average (47.9) P/E for companies in the medical equipment industry.
Utah Medical Products’s P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Utah Medical Products, it’s quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The ‘Price’ in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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.
How Does Utah Medical Products’s Debt Impact Its P/E Ratio?
Since Utah Medical Products holds net cash of US$49m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Verdict On Utah Medical Products’s P/E Ratio
Utah Medical Products trades on a P/E ratio of 27.7, which is above the US market average of 17.9. The recent drop in earnings per share would make some investors cautious, but the relatively strong balance sheet will allow the company time to invest in growth. Clearly, the high P/E indicates shareholders think it will!
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. We don’t have analyst forecasts, but you might want to assess this data-rich visualization of earnings, revenue and cash flow.
But note: Utah Medical Products 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).
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.