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 United States Cellular Corporation's (NYSE:USM) P/E ratio could help you assess the value on offer. What is United States Cellular's P/E ratio? Well, based on the last twelve months it is 23.28. That corresponds to an earnings yield of approximately 4.3%.
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 United States Cellular:
P/E of 23.28 = $34.59 ÷ $1.49 (Based on the trailing twelve months to September 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 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 United States Cellular's P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. You can see in the image below that the average P/E (21.9) for companies in the wireless telecom industry is roughly the same as United States Cellular's P/E.
United States Cellular's P/E tells us that market participants think its prospects are roughly in line with its industry. So if United States Cellular actually outperforms its peers going forward, that should be a positive for the share price. Further research into factors such as insider buying and selling, could help you form your own view on whether that is likely.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. When earnings grow, the 'E' increases, over time. That means unless the share price increases, the P/E will reduce in a few years. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
United States Cellular saw earnings per share decrease by 69% last year. But it has grown its earnings per share by 35% per year over the last three years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The 'Price' in P/E reflects the market capitalization of the company. That means it doesn't take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
United States Cellular's Balance Sheet
United States Cellular has net debt equal to 35% of its market cap. You'd want to be aware of this fact, but it doesn't bother us.
The Verdict On United States Cellular's P/E Ratio
United States Cellular's P/E is 23.3 which is above average (18.7) in its market. 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 report on the analyst consensus forecasts could help you make a master move on this stock.
Of course you might be able to find a better stock than United States Cellular. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.
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