This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll look at Reliance Steel & Aluminum Co.'s (NYSE:RS) P/E ratio and reflect on what it tells us about the company's share price. Reliance Steel & Aluminum has a P/E ratio of 11.03, based on the last twelve months. That corresponds to an earnings yield of approximately 9.1%.
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 Reliance Steel & Aluminum:
P/E of 11.03 = $97.23 ÷ $8.81 (Based on the trailing twelve months to June 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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.
Does Reliance Steel & Aluminum 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. If you look at the image below, you can see Reliance Steel & Aluminum has a lower P/E than the average (12.9) in the metals and mining industry classification.
Its relatively low P/E ratio indicates that Reliance Steel & Aluminum shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. You should delve deeper. I like to check if company insiders have been buying or selling.
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. Earnings growth means that in the future the 'E' will be higher. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Reliance Steel & Aluminum shrunk earnings per share by 20% over the last year. But it has grown its earnings per share by 15% per year over the last five years.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
The 'Price' in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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 Reliance Steel & Aluminum's P/E?
Reliance Steel & Aluminum has net debt equal to 29% of its market cap. While that's enough to warrant consideration, it doesn't really concern us.
The Bottom Line On Reliance Steel & Aluminum's P/E Ratio
Reliance Steel & Aluminum has a P/E of 11. That's below the average in the US market, which is 17.3. Since it only carries a modest debt load, it's likely the low expectations implied by the P/E ratio arise from the lack of recent earnings growth.
When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
But note: Reliance Steel & Aluminum 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).
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 firstname.lastname@example.org. 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.