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 Telephone and Data Systems Inc’s (NYSE:TDS) P/E ratio to inform your assessment of the investment opportunity. Telephone and Data Systems has a price to earnings ratio of 18.84, based on the last twelve months. That is equivalent to an earnings yield of about 5.3%.
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 Telephone and Data Systems:
P/E of 18.84 = $29.95 ÷ $1.59 (Based on the trailing twelve months to June 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
Companies that shrink earnings per share quickly will rapidly decrease the ‘E’ in the equation. 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.
Telephone and Data Systems increased earnings per share by a whopping 225% last year. And earnings per share have improved by 4.5% annually, over the last five years. With that performance, I would expect it to have an above average P/E ratio. In contrast, EPS has decreased by 8.2%, annually, over 3 years.
How Does Telephone and Data Systems’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. If you look at the image below, you can see Telephone and Data Systems has a lower P/E than the average (21.7) in the wireless telecom industry classification.
Telephone and Data Systems’s P/E tells us that market participants think it will not fare as well as its peers in the same industry. 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.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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.
Telephone and Data Systems’s Balance Sheet
Net debt totals 46% of Telephone and Data Systems’s market cap. This is a reasonably significant level of debt — all else being equal you’d expect a much lower P/E than if it had net cash.
The Bottom Line On Telephone and Data Systems’s P/E Ratio
Telephone and Data Systems’s P/E is 18.8 which is about average (18.5) in the US market. Given it has reasonable debt levels, and grew earnings strongly last year, the P/E indicates the market has doubts this growth can be sustained.
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 they key to an excellent investment decision.
You might be able to find a better buy than Telephone and Data Systems. 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 email@example.com.