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Should You Be Tempted To Sell Wabtec Corporation (NYSE:WAB) 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. We'll look at Wabtec Corporation's (NYSE:WAB) P/E ratio and reflect on what it tells us about the company's share price. Wabtec has a P/E ratio of 49.91, based on the last twelve months. That means that at current prices, buyers pay $49.91 for every $1 in trailing yearly profits.

Check out our latest analysis for Wabtec

How Do I Calculate Wabtec's Price To Earnings Ratio?

The formula for P/E is:

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

Or for Wabtec:

P/E of 49.91 = $76.50 ÷ $1.53 (Based on the trailing twelve months to September 2019.)

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. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.

How Does Wabtec'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, Wabtec has a higher P/E than the average company (22.4) in the machinery industry.

NYSE:WAB Price Estimation Relative to Market, December 6th 2019
NYSE:WAB Price Estimation Relative to Market, December 6th 2019

That means that the market expects Wabtec will outperform other companies in its industry. Clearly the market expects growth, but it isn't guaranteed. So further research is always essential. I often monitor director buying and selling.

How Growth Rates Impact P/E Ratios

Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. Then, a higher P/E might scare off shareholders, pushing the share price down.

Wabtec shrunk earnings per share by 52% over the last year. And over the longer term (5 years) earnings per share have decreased 15% annually. This might lead to muted expectations.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

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. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.

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

Wabtec has net debt equal to 28% of its market cap. While that's enough to warrant consideration, it doesn't really concern us.

The Verdict On Wabtec's P/E Ratio

Wabtec's P/E is 49.9 which is above average (18.3) 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 have an opportunity when market expectations about a stock are wrong. 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 report on the analyst consensus forecasts could help you make a master move on this stock.

You might be able to find a better buy than Wabtec. 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).

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.

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. Thank you for reading.