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Is WEX Inc.'s (NYSE:WEX) High P/E Ratio A Problem For Investors?

Simply Wall St

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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll show how you can use WEX Inc.'s (NYSE:WEX) P/E ratio to inform your assessment of the investment opportunity. Looking at earnings over the last twelve months, WEX has a P/E ratio of 60.65. That is equivalent to an earnings yield of about 1.6%.

View our latest analysis for WEX

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 WEX:

P/E of 60.65 = $185.96 ÷ $3.07 (Based on the year to March 2019.)

Is A High Price-to-Earnings Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. That isn't necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.

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. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

WEX saw earnings per share decrease by 28% last year. But EPS is up 5.0% over the last 3 years. And EPS is down 5.3% a year, over the last 5 years. This might lead to muted expectations.

How Does WEX's P/E Ratio Compare To Its Peers?

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 WEX has a higher P/E than the average (31.5) P/E for companies in the it industry.

NYSE:WEX Price Estimation Relative to Market, June 4th 2019
NYSE:WEX Price Estimation Relative to Market, June 4th 2019

Its relatively high P/E ratio indicates that WEX shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn't guaranteed. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

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

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. So it won't reflect the advantage of cash, or disadvantage of debt. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on 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).

Is Debt Impacting WEX's P/E?

Net debt is 34% of WEX's market cap. You'd want to be aware of this fact, but it doesn't bother us.

The Bottom Line On WEX's P/E Ratio

WEX's P/E is 60.6 which suggests the market is more focussed on the future opportunity rather than the current level of earnings. 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 visual report on analyst forecasts could hold the key to an excellent investment decision.

But note: WEX 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.