The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll look at Phibro Animal Health Corporation’s (NASDAQ:PAHC) P/E ratio and reflect on what it tells us about the company’s share price. Based on the last twelve months, Phibro Animal Health’s P/E ratio is 19.24. That corresponds to an earnings yield of approximately 5.2%.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Phibro Animal Health:
P/E of 19.24 = $31.18 ÷ $1.62 (Based on the year to September 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 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
When earnings fall, the ‘E’ decreases, over time. That means unless the share price falls, the P/E will increase in a few years. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
Phibro Animal Health’s earnings per share fell by 5.9% in the last twelve months. But it has grown its earnings per share by 21% per year over the last five years. And it has shrunk its earnings per share by 6.8% per year over the last three years. This growth rate might warrant a low P/E ratio. So it would be surprising to see a high P/E.
How Does Phibro Animal Health’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. You can see in the image below that the average P/E (16.2) for companies in the pharmaceuticals industry is lower than Phibro Animal Health’s P/E.
Phibro Animal Health’s P/E tells us that market participants think the company will perform better than its industry peers, going forward. The market is optimistic about the future, but that doesn’t guarantee future growth. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
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. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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.
Phibro Animal Health’s Balance Sheet
Phibro Animal Health’s net debt is 19% of its market cap. This could bring some additional risk, and reduce the number of investment options for management; worth remembering if you compare its P/E to businesses without debt.
The Bottom Line On Phibro Animal Health’s P/E Ratio
Phibro Animal Health has a P/E of 19.2. That’s higher than the average in the US market, which is 15.6. With a bit of debt, but a lack of recent growth, it’s safe to say the market is expecting improved profit performance from the company, in the next few years.
Investors should be looking to buy stocks that the market is wrong about. 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 they key to an excellent investment decision.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
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.