This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll look at Taylor Devices, Inc.’s (NASDAQ:TAYD) P/E ratio and reflect on what it tells us about the company’s share price. Based on the last twelve months, Taylor Devices’s P/E ratio is 37.39. That corresponds to an earnings yield of approximately 2.7%.
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How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Taylor Devices:
P/E of 37.39 = $13 ÷ $0.35 (Based on the year to November 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
If earnings fall then in the future the ‘E’ will be lower. That means even if the current P/E is low, it will increase over time if the share price stays flat. Then, a higher P/E might scare off shareholders, pushing the share price down.
Taylor Devices’s earnings per share fell by 22% in the last twelve months. And EPS is down 3.4% a year, over the last 5 years. This might lead to muted expectations.
How Does Taylor Devices’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. You can see in the image below that the average P/E (18.6) for companies in the machinery industry is lower than Taylor Devices’s P/E.
Its relatively high P/E ratio indicates that Taylor Devices shareholders think it will perform better than other companies in its industry classification. 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.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don’t forget that the P/E ratio considers market capitalization. In other words, it does not consider any debt or cash that the company may have on the balance sheet. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
How Does Taylor Devices’s Debt Impact Its P/E Ratio?
Taylor Devices has net cash of US$6.0m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Verdict On Taylor Devices’s P/E Ratio
Taylor Devices has a P/E of 37.4. That’s higher than the average in the US market, which is 16.7. The recent drop in earnings per share would make some investors cautious, but the net cash position means the company has time to improve: and the high P/E suggests the market thinks it will.
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.’ Although we don’t have analyst forecasts, you might want to assess this data-rich visualization of earnings, revenue and cash flow.
You might be able to find a better buy than Taylor Devices. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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.