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 Visteon Corporation's (NASDAQ:VC) P/E ratio could help you assess the value on offer. What is Visteon's P/E ratio? Well, based on the last twelve months it is 13.84. That corresponds to an earnings yield of approximately 7.2%.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Visteon:
P/E of 13.84 = $76.47 ÷ $5.53 (Based on the trailing twelve months to December 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 isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. When earnings grow, the 'E' increases, over time. That means unless the share price increases, the P/E will reduce in a few years. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Visteon increased earnings per share by 9.8% last year. But earnings per share are down 10% per year over the last five years.
Does Visteon Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. The image below shows that Visteon has a P/E ratio that is roughly in line with the auto components industry average (14.8).
Visteon's P/E tells us that market participants think its prospects are roughly in line with its industry. The company could surprise by performing better than average, in the future. Further research into factors such asmanagement tenure, could help you form your own view on whether that is likely.
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. So it won't reflect the advantage of cash, or disadvantage of debt. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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).
How Does Visteon's Debt Impact Its P/E Ratio?
The extra options and safety that comes with Visteon's US$58m 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 Visteon's P/E Ratio
Visteon's P/E is 13.8 which is below average (17.9) in the US market. EPS was up modestly better over the last twelve months. And the healthy balance sheet means the company can sustain growth while the P/E suggests shareholders don't think it will.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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 report on the analyst consensus forecasts could help you make a master move on this stock.
Of course you might be able to find a better stock than Visteon. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.
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.