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Is Sturm, Ruger & Company, Inc.'s (NYSE:RGR) High P/E Ratio A Problem For Investors?

Simply Wall St

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 Sturm, Ruger & Company, Inc.'s (NYSE:RGR) P/E ratio to inform your assessment of the investment opportunity. What is Sturm Ruger's P/E ratio? Well, based on the last twelve months it is 18.43. That means that at current prices, buyers pay $18.43 for every $1 in trailing yearly profits.

See our latest analysis for Sturm Ruger

How Do You Calculate A P/E Ratio?

The formula for P/E is:

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

Or for Sturm Ruger:

P/E of 18.43 = $53.78 ÷ $2.92 (Based on the year to December 2018.)

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.

How Growth Rates Impact P/E Ratios

When earnings fall, the 'E' decreases, over time. 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.

Sturm Ruger had pretty flat EPS growth in the last year. And EPS is down 13% a year, over the last 5 years. So you wouldn't expect a very high P/E.

How Does Sturm Ruger's P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. As you can see below, Sturm Ruger has a higher P/E than the average company (16.9) in the leisure industry.

NYSE:RGR Price Estimation Relative to Market, April 23rd 2019

Sturm Ruger's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Clearly the market expects growth, but it isn't guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.

Remember: P/E Ratios Don't Consider The Balance Sheet

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. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).

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.

Sturm Ruger's Balance Sheet

With net cash of US$153m, Sturm Ruger has a very strong balance sheet, which may be important for its business. Having said that, at 16% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.

The Bottom Line On Sturm Ruger's P/E Ratio

Sturm Ruger has a P/E of 18.4. That's around the same as the average in the US market, which is 18. While the lack of recent growth is probably muting optimism, the healthy balance sheet means the company retains potential for future growth. So it's not surprising to see it trade on a P/E roughly in line with the market.

Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

But note: Sturm Ruger 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 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. Thank you for reading.