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Why Mastercard Incorporated's (NYSE:MA) High P/E Ratio Isn't Necessarily A Bad Thing

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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 look at Mastercard Incorporated's (NYSE:MA) P/E ratio and reflect on what it tells us about the company's share price. Mastercard has a P/E ratio of 40.99, based on the last twelve months. That means that at current prices, buyers pay $40.99 for every $1 in trailing yearly profits.

See our latest analysis for Mastercard

How Do You Calculate Mastercard's P/E Ratio?

The formula for P/E is:

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

Or for Mastercard:

P/E of 40.99 = $277.15 ÷ $6.76 (Based on the trailing twelve months to September 2019.)

Is A High P/E 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 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 Mastercard Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio essentially measures market expectations of a company. The image below shows that Mastercard has a higher P/E than the average (35.7) P/E for companies in the it industry.

NYSE:MA Price Estimation Relative to Market, October 31st 2019
NYSE:MA Price Estimation Relative to Market, October 31st 2019

Its relatively high P/E ratio indicates that Mastercard shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. That means even if the current P/E is high, it will reduce over time if the share price stays flat. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Notably, Mastercard grew EPS by a whopping 36% in the last year. And earnings per share have improved by 18% annually, over the last five years. So we'd generally expect it to have a relatively high P/E ratio.

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

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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 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.

Mastercard's Balance Sheet

Mastercard has net debt worth just 0.5% of its market capitalization. It would probably trade on a higher P/E ratio if it had a lot of cash, but I doubt it is having a big impact.

The Bottom Line On Mastercard's P/E Ratio

Mastercard's P/E is 41.0 which is above average (17.9) in its market. 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.

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 visual report on analyst forecasts could hold the key to an excellent investment decision.

You might be able to find a better buy than Mastercard. 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.