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Should You Be Tempted To Sell Applied Industrial Technologies, Inc. (NYSE:AIT) Because Of Its P/E Ratio?

Cameron Brookes

This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll look at Applied Industrial Technologies, Inc.’s (NYSE:AIT) P/E ratio and reflect on what it tells us about the company’s share price. Applied Industrial Technologies has a price to earnings ratio of 14.12, based on the last twelve months. That is equivalent to an earnings yield of about 7.1%.

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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 Applied Industrial Technologies:

P/E of 14.12 = $57.23 ÷ $4.05 (Based on the trailing twelve months to September 2018.)

Is A High P/E 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

Earnings growth rates have a big influence on P/E ratios. 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.

Applied Industrial Technologies increased earnings per share by an impressive 13% over the last twelve months. And it has bolstered its earnings per share by 6.8% per year over the last five years. With that performance, you might expect an above average P/E ratio.

How Does Applied Industrial Technologies’s P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. As you can see below, Applied Industrial Technologies has a higher P/E than the average company (12.3) in the trade distributors industry.

NYSE:AIT PE PEG Gauge January 11th 19

That means that the market expects Applied Industrial Technologies will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

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. That means it doesn’t take debt or cash into account. 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.

Applied Industrial Technologies’s Balance Sheet

Applied Industrial Technologies has net debt worth 44% of its market capitalization. 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 Applied Industrial Technologies’s P/E Ratio

Applied Industrial Technologies’s P/E is 14.1 which is below average (16.8) in the US market. The company does have a little debt, and EPS growth was good last year. The low P/E ratio suggests current market expectations are muted, implying these levels of growth will not continue. Given analysts are expecting further growth, one might have expected a higher P/E ratio. That may be worth further research.

Investors should be looking to buy stocks that the market is wrong about. 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 visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.

You might be able to find a better buy than Applied Industrial Technologies. 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 editorial-team@simplywallst.com.