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Why Funko, Inc.'s (NASDAQ:FNKO) High P/E Ratio Isn't Necessarily A Bad Thing

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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll show how you can use Funko, Inc.'s (NASDAQ:FNKO) P/E ratio to inform your assessment of the investment opportunity. What is Funko's P/E ratio? Well, based on the last twelve months it is 47.8. In other words, at today's prices, investors are paying \$47.8 for every \$1 in prior year profit.

How Do You Calculate A P/E Ratio?

The formula for P/E is:

Price to Earnings Ratio = Price per Share Ã· Earnings per Share (EPS)

Or for Funko:

P/E of 47.8 = \$20.59 Ã· \$0.43 (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 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

When earnings fall, the 'E' decreases, over time. That means even if the current P/E is low, it will increase over time if the share price stays flat. Then, a higher P/E might scare off shareholders, pushing the share price down.

It's nice to see that Funko grew EPS by a stonking 33% in the last year. Unfortunately, earnings per share are down 62% a year, over 5 years.

Does Funko 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. As you can see below, Funko has a higher P/E than the average company (19.4) in the retail distributors industry.

That means that the market expects Funko will outperform other companies in its industry. Clearly the market expects growth, but it isn't guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.

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. Thus, the metric does not reflect cash or debt held by the company. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).

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.

How Does Funko's Debt Impact Its P/E Ratio?

Net debt totals 22% of Funko'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 Funko's P/E Ratio

Funko trades on a P/E ratio of 47.8, which is above the US market average of 17.5. While the company does use modest debt, its recent earnings growth is superb. So to be frank we are not surprised it has a high P/E ratio.

Investors have an opportunity when market expectations about a stock are wrong. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine.' So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

You might be able to find a better buy than Funko. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

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.