This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll show how you can use HEICO Corporation's (NYSE:HEI) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, HEICO's P/E ratio is 53.70. In other words, at today's prices, investors are paying $53.70 for every $1 in prior year profit.
How Do You Calculate HEICO's P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for HEICO:
P/E of 53.70 = $124.74 ÷ $2.32 (Based on the trailing twelve months to July 2019.)
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.
Does HEICO 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. The image below shows that HEICO has a higher P/E than the average (23.3) P/E for companies in the aerospace & defense industry.
HEICO's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Shareholders are clearly optimistic, but the future is always uncertain. So investors should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. 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.
HEICO increased earnings per share by a whopping 25% last year. And it has bolstered its earnings per share by 20% per year over the last five years. With that performance, I would expect it to have an above average P/E ratio.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. So it won't reflect the advantage of cash, or disadvantage of debt. 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.
Is Debt Impacting HEICO's P/E?
HEICO's net debt is 3.9% of its market cap. The market might award it a higher P/E ratio if it had net cash, but its unlikely this low level of net borrowing is having a big impact on the P/E multiple.
The Verdict On HEICO's P/E Ratio
HEICO's P/E is 53.7 which suggests the market is more focussed on the future opportunity rather than the current level of earnings. The company is not overly constrained by its modest debt levels, and its recent EPS growth very solid. Therefore, it's not particularly surprising that it has a above average P/E ratio.
Investors have an opportunity when market expectations about a stock are wrong. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
You might be able to find a better buy than HEICO. 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).
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If you spot an error that warrants correction, please contact the editor at email@example.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.