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Should You Be Tempted To Sell PerkinElmer, Inc. (NYSE:PKI) Because Of Its P/E Ratio?

Simply Wall St

Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. To keep it practical, we'll show how PerkinElmer, Inc.'s (NYSE:PKI) P/E ratio could help you assess the value on offer. What is PerkinElmer's P/E ratio? Well, based on the last twelve months it is 41.04. In other words, at today's prices, investors are paying $41.04 for every $1 in prior year profit.

See our latest analysis for PerkinElmer

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 PerkinElmer:

P/E of 41.04 = $87.08 ÷ $2.12 (Based on the year to September 2019.)

Is A High P/E Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. 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 Does PerkinElmer's P/E Ratio Compare To Its Peers?

One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. As you can see below, PerkinElmer has a higher P/E than the average company (32.6) in the life sciences industry.

NYSE:PKI Price Estimation Relative to Market, November 6th 2019

That means that the market expects PerkinElmer 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.

How Growth Rates Impact P/E Ratios

Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. And in that case, the P/E ratio itself will drop rather quickly. Then, a lower P/E should attract more buyers, pushing the share price up.

In the last year, PerkinElmer grew EPS like Taylor Swift grew her fan base back in 2010; the 83% gain was both fast and well deserved. Having said that, the average EPS growth over the last three years wasn't so good, coming in at 5.7%.

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

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. That means it doesn't take debt or cash into account. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.

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.

So What Does PerkinElmer's Balance Sheet Tell Us?

PerkinElmer's net debt is 19% of its market cap. It would probably deserve a higher P/E ratio if it was net cash, since it would have more options for growth.

The Bottom Line On PerkinElmer's P/E Ratio

PerkinElmer has a P/E of 41.0. That's higher than the average in its market, which is 18.3. While the company does use modest debt, its recent earnings growth is superb. So on this analysis a high P/E ratio seems reasonable.

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. 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 PerkinElmer. 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).

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.