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Why Harley-Davidson, Inc.’s (NYSE:HOG) High P/E Ratio Isn’t Necessarily A Bad Thing

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 Harley-Davidson, Inc.’s (NYSE:HOG) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Harley-Davidson’s P/E ratio is 11.57. That means that at current prices, buyers pay \$11.57 for every \$1 in trailing yearly profits.

How Do You Calculate A P/E Ratio?

The formula for P/E is:

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

Or for Harley-Davidson:

P/E of 11.57 = \$37.12 ÷ \$3.21 (Based on the trailing twelve months to December 2018.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that buyers have to pay a higher price for each \$1 the company has earned over the last year. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.

How Growth Rates Impact P/E Ratios

Companies that shrink earnings per share quickly will rapidly decrease the ‘E’ in the equation. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.

Harley-Davidson increased earnings per share by 5.7% last year. But earnings per share are down 4.1% per year over the last five years.

How Does Harley-Davidson’s P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Harley-Davidson has a higher P/E than the average (10.2) P/E for companies in the auto industry.

That means that the market expects Harley-Davidson 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

Don’t forget that the P/E ratio considers market capitalization. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.

How Does Harley-Davidson’s Debt Impact Its P/E Ratio?

Harley-Davidson has net debt worth a very significant 107% of its market capitalization. This level of debt justifies a relatively low P/E, so remain cognizant of the debt, if you’re comparing it to other stocks.

The Bottom Line On Harley-Davidson’s P/E Ratio

Harley-Davidson’s P/E is 11.6 which is below average (17.6) in the US market. It’s good to see EPS growth in the last 12 months, but the debt on the balance sheet might be muting expectations.

Investors should be looking to buy stocks that the market is wrong about. 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 Harley-Davidson. 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.