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Is USA Truck, Inc.'s (NASDAQ:USAK) P/E Ratio Really That Good?

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 show how you can use USA Truck, Inc.'s (NASDAQ:USAK) P/E ratio to inform your assessment of the investment opportunity. Looking at earnings over the last twelve months, USA Truck has a P/E ratio of 6.80. In other words, at today's prices, investors are paying $6.80 for every $1 in prior year profit.

View our latest analysis for USA Truck

How Do You Calculate A P/E Ratio?

The formula for P/E is:

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

Or for USA Truck:

P/E of 6.80 = $8.23 ÷ $1.21 (Based on the trailing twelve months to June 2019.)

Is A High P/E Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.

Does USA Truck 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. If you look at the image below, you can see USA Truck has a lower P/E than the average (18.3) in the transportation industry classification.

NasdaqGS:USAK Price Estimation Relative to Market, October 31st 2019
NasdaqGS:USAK Price Estimation Relative to Market, October 31st 2019

Its relatively low P/E ratio indicates that USA Truck shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with USA Truck, it's quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.

How Growth Rates Impact P/E Ratios

Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. When earnings grow, the 'E' increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

USA Truck's earnings per share fell by 48% in the last twelve months. But it has grown its earnings per share by 49% per year over the last three years.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

Don't forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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.

USA Truck's Balance Sheet

USA Truck's net debt is considerable, at 143% of its market cap. This is a relatively high level of debt, so the stock probably deserves a relatively low P/E ratio. Keep that in mind when comparing it to other companies.

The Bottom Line On USA Truck's P/E Ratio

USA Truck's P/E is 6.8 which is below average (17.9) in the US market. The P/E reflects market pessimism that probably arises from the lack of recent EPS growth, paired with significant leverage.

When the market is wrong about a stock, it gives savvy investors an opportunity. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

But note: USA Truck 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 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.