Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at United States Lime & Minerals, Inc.'s (NASDAQ:USLM) P/E ratio and reflect on what it tells us about the company's share price. What is United States Lime & Minerals's P/E ratio? Well, based on the last twelve months it is 22.07. In other words, at today's prices, investors are paying $22.07 for every $1 in prior year profit.
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How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for United States Lime & Minerals:
P/E of 22.07 = $81 ÷ $3.67 (Based on the trailing twelve months to March 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each $1 of company 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. And in that case, the P/E ratio itself will drop rather quickly. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
United States Lime & Minerals saw earnings per share decrease by 24% last year. But over the longer term (5 years) earnings per share have increased by 4.3%.
Does United States Lime & Minerals Have A Relatively High Or Low P/E For Its Industry?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. The image below shows that United States Lime & Minerals has a lower P/E than the average (25.3) P/E for companies in the basic materials industry.
Its relatively low P/E ratio indicates that United States Lime & Minerals 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. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
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. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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 Lime & Minerals's Balance Sheet
United States Lime & Minerals has net cash of US$64m. This is fairly high at 14% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.
The Verdict On United States Lime & Minerals's P/E Ratio
United States Lime & Minerals has a P/E of 22.1. That's higher than the average in the US market, which is 17.4. The recent drop in earnings per share would make some investors cautious, but the relatively strong balance sheet will allow the company time to invest in growth. Clearly, the high P/E indicates shareholders think it will!
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. Although we don't have analyst forecasts, you might want to assess this data-rich visualization of earnings, revenue and cash flow.
But note: United States Lime & Minerals 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 firstname.lastname@example.org. 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.