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Why EPAM Systems, Inc.'s (NYSE:EPAM) High P/E Ratio Isn't Necessarily A Bad Thing

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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to EPAM Systems, Inc.'s (NYSE:EPAM), to help you decide if the stock is worth further research. EPAM Systems has a P/E ratio of 43.95, based on the last twelve months. That means that at current prices, buyers pay $43.95 for every $1 in trailing yearly profits.

Check out our latest analysis for EPAM Systems

How Do I Calculate EPAM Systems's Price To Earnings Ratio?

The formula for P/E is:

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

Or for EPAM Systems:

P/E of 43.95 = $192.87 ÷ $4.39 (Based on the year to March 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 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.

Does EPAM Systems Have A Relatively High Or Low P/E For Its Industry?

We can get an indication of market expectations by looking at the P/E ratio. You can see in the image below that the average P/E (35.2) for companies in the it industry is lower than EPAM Systems's P/E.

NYSE:EPAM Price Estimation Relative to Market, July 20th 2019

Its relatively high P/E ratio indicates that EPAM Systems shareholders think it will perform better than other companies in its industry classification. 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

P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the 'E' will be higher. 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.

EPAM Systems's earnings made like a rocket, taking off 103% last year. The cherry on top is that the five year growth rate was an impressive 25% per year. With that kind of growth rate we would generally expect a high P/E ratio.

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

Don't forget that the P/E ratio considers market capitalization. That means it doesn't take debt or cash into account. 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).

EPAM Systems's Balance Sheet

Since EPAM Systems holds net cash of US$738m, it can spend on growth, justifying a higher P/E ratio than otherwise.

The Bottom Line On EPAM Systems's P/E Ratio

EPAM Systems has a P/E of 44. That's higher than the average in its market, which is 17.9. Its net cash position is the cherry on top of its superb EPS growth. To us, this is the sort of company that we would expect to carry an above average price tag (relative to earnings).

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. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.

But note: EPAM Systems 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.