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Should You Be Tempted To Sell Rexnord Corporation (NYSE:RXN) Because Of Its P/E Ratio?

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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we’ll show how Rexnord Corporation’s (NYSE:RXN) P/E ratio could help you assess the value on offer. Based on the last twelve months, Rexnord’s P/E ratio is 58.72. In other words, at today’s prices, investors are paying $58.72 for every $1 in prior year profit.

Check out our latest analysis for Rexnord

How Do You Calculate A P/E Ratio?

The formula for P/E is:

Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)

Or for Rexnord:

P/E of 58.72 = $28 ÷ $0.48 (Based on the trailing twelve months to December 2018.)

Is A High P/E Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. All else being equal, it’s better to pay a low price — but as Warren Buffett said, ‘It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.’

How Growth Rates Impact P/E Ratios

Companies that shrink earnings per share quickly will rapidly decrease the ‘E’ in the equation. That means even if the current P/E is low, it will increase over time if the share price stays flat. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.

Rexnord saw earnings per share decrease by 67% last year. But it has grown its earnings per share by 4.2% per year over the last five years. And EPS is down 4.9% a year, over the last 3 years. This might lead to low expectations.

How Does Rexnord’s P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. As you can see below, Rexnord has a higher P/E than the average company (19.7) in the machinery industry.

NYSE:RXN PE PEG Gauge February 18th 19
NYSE:RXN PE PEG Gauge February 18th 19

Its relatively high P/E ratio indicates that Rexnord shareholders think it will perform better than other companies in its industry classification. 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.

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

The ‘Price’ in P/E reflects the market capitalization of the company. That means it doesn’t take debt or cash into account. Theoretically, a business can improve its earnings (and produce a lower P/E in the future), by taking on debt (or spending its remaining cash).

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 Rexnord’s P/E?

Rexnord’s net debt is 35% of its market cap. This is enough debt that you’d have to make some adjustments before using the P/E ratio to compare it to a company with net cash.

The Bottom Line On Rexnord’s P/E Ratio

Rexnord has a P/E of 58.7. That’s significantly higher than the average in the US market, which is 17.2. With some debt but no EPS growth last year, the market has high expectations of future profits.

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 report on the analyst consensus forecasts could help you make a master move on this stock.

But note: Rexnord may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

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. On rare occasion, data errors may occur. Thank you for reading.

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