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

Simply Wall St

The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll show how you can use Patterson Companies, Inc.'s (NASDAQ:PDCO) P/E ratio to inform your assessment of the investment opportunity. Patterson Companies has a price to earnings ratio of 41.76, based on the last twelve months. In other words, at today's prices, investors are paying $41.76 for every $1 in prior year profit.

Check out our latest analysis for Patterson Companies

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 Patterson Companies:

P/E of 41.76 = $21.430 ÷ $0.513 (Based on the trailing twelve months to January 2020.)

(Note: the above calculation results may not be precise due to rounding.)

Is A High P/E Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing 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 Does Patterson Companies's P/E Ratio Compare To Its Peers?

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 (22.9) for companies in the healthcare industry is lower than Patterson Companies's P/E.

NasdaqGS:PDCO Price Estimation Relative to Market, March 10th 2020

Its relatively high P/E ratio indicates that Patterson Companies 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

Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. 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.

Patterson Companies shrunk earnings per share by 39% over the last year. And EPS is down 23% a year, over the last 5 years. This growth rate might warrant a below average P/E ratio.

Remember: P/E Ratios Don't Consider The Balance Sheet

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. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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.

So What Does Patterson Companies's Balance Sheet Tell Us?

Net debt is 29% of Patterson Companies's market cap. While it's worth keeping this in mind, it isn't a worry.

The Verdict On Patterson Companies's P/E Ratio

Patterson Companies trades on a P/E ratio of 41.8, which is above its market average of 15.1. With some debt but no EPS growth last year, the market has high expectations of future profits.

Investors should be looking to buy stocks that the market is wrong about. 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 Patterson Companies. 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).

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.

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. Thank you for reading.