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Should You Be Tempted To Sell Silicon Laboratories Inc. (NASDAQ:SLAB) Because Of Its P/E Ratio?

Simply Wall St

This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to Silicon Laboratories Inc.'s (NASDAQ:SLAB), to help you decide if the stock is worth further research. What is Silicon Laboratories's P/E ratio? Well, based on the last twelve months it is 44.68. That corresponds to an earnings yield of approximately 2.2%.

View our latest analysis for Silicon Laboratories

How Do You Calculate A P/E Ratio?

The formula for price to earnings is:

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

Or for Silicon Laboratories:

P/E of 44.68 = $86.54 ÷ $1.94 (Based on the year to December 2018.)

Is A High Price-to-Earnings 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 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 even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.

Silicon Laboratories's 74% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. And earnings per share have improved by 40% annually, over the last three years. So you might say it really deserves to have an above-average P/E ratio.

Does Silicon Laboratories Have A Relatively High Or Low P/E For Its Industry?

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 (19.7) for companies in the semiconductor industry is lower than Silicon Laboratories's P/E.

NasdaqGS:SLAB Price Estimation Relative to Market, April 10th 2019

Its relatively high P/E ratio indicates that Silicon Laboratories shareholders think it will perform better than other companies in its industry classification. The market is optimistic about the future, but that doesn't guarantee future growth. So further research is always essential. I often monitor director buying and selling.

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

Don't forget that the P/E ratio considers market capitalization. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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 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.

How Does Silicon Laboratories's Debt Impact Its P/E Ratio?

Since Silicon Laboratories holds net cash of US$259m, it can spend on growth, justifying a higher P/E ratio than otherwise.

The Bottom Line On Silicon Laboratories's P/E Ratio

Silicon Laboratories's P/E is 44.7 which is above average (17.9) in the US market. Its net cash position is the cherry on top of its superb EPS growth. To us, this is the sort of company that we would expect to carry an above average price tag (relative to earnings).

When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

Of course you might be able to find a better stock than Silicon Laboratories. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.