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Why frontdoor, inc.'s (NASDAQ:FTDR) High P/E Ratio Isn't Necessarily A Bad Thing

Simply Wall St

Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll apply a basic P/E ratio analysis to frontdoor, inc.'s (NASDAQ:FTDR), to help you decide if the stock is worth further research. frontdoor has a P/E ratio of 31.61, based on the last twelve months. In other words, at today's prices, investors are paying $31.61 for every $1 in prior year profit.

See our latest analysis for frontdoor

How Do You Calculate A P/E Ratio?

The formula for price to earnings is:

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

Or for frontdoor:

P/E of 31.61 = $46.75 ÷ $1.48 (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 is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.

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

The P/E ratio indicates whether the market has higher or lower expectations of a company. You can see in the image below that the average P/E (25.8) for companies in the consumer services industry is lower than frontdoor's P/E.

NasdaqGS:FTDR Price Estimation Relative to Market, July 29th 2019

That means that the market expects frontdoor will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. So investors should delve deeper. I like to check if company insiders have been buying or selling.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. 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.

frontdoor saw earnings per share decrease by 12% last year.

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

The 'Price' in P/E reflects the market capitalization of the company. 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.

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.

Is Debt Impacting frontdoor's P/E?

Net debt totals 17% of frontdoor's market cap. It would probably deserve a higher P/E ratio if it was net cash, since it would have more options for growth.

The Bottom Line On frontdoor's P/E Ratio

frontdoor's P/E is 31.6 which is above average (18) in its market. With modest debt but no EPS growth in the last year, it's fair to say the P/E implies some optimism about future earnings, from the market.

Investors have an opportunity when market expectations about a stock are wrong. 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.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E 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.