This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll look at United-Guardian, Inc.’s (NASDAQ:UG) P/E ratio and reflect on what it tells us about the company’s share price. Based on the last twelve months, United-Guardian’s P/E ratio is 17.98. That is equivalent to an earnings yield of about 5.6%.
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How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for United-Guardian:
P/E of 17.98 = $18.72 ÷ $1.04 (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
Earnings growth rates have a big influence on P/E ratios. Earnings growth means that in the future the ‘E’ will be higher. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
Notably, United-Guardian grew EPS by a whopping 34% in the last year. And earnings per share have improved by 2.7% annually, over the last three years. So we’d generally expect it to have a relatively high P/E ratio. In contrast, EPS has decreased by 8.6%, annually, over 5 years.
How Does United-Guardian’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. If you look at the image below, you can see United-Guardian has a lower P/E than the average (21.6) in the personal products industry classification.
Its relatively low P/E ratio indicates that United-Guardian shareholders think it will struggle to do as well as other companies in its industry classification. Many investors like to buy stocks when the market is pessimistic about their prospects. You should delve deeper. I like to check if company insiders have been buying or selling.
Remember: P/E Ratios Don’t Consider The Balance Sheet
It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. 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 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.
Is Debt Impacting United-Guardian’s P/E?
Since United-Guardian holds net cash of US$9.9m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Verdict On United-Guardian’s P/E Ratio
United-Guardian has a P/E of 18. That’s around the same as the average in the US market, which is 17. With a strong balance sheet combined with recent growth, the P/E implies the market is quite pessimistic.
When the market is wrong about a stock, it gives savvy investors an opportunity. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. Although we don’t have analyst forecasts, shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
Of course you might be able to find a better stock than United-Guardian. So you may wish to see this free collection of other companies that have grown earnings strongly.
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 email@example.com.