Why Paylocity Holding Corporation’s (NASDAQ:PCTY) High P/E Ratio Isn’t Necessarily A Bad Thing
The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll look at Paylocity Holding Corporation’s (NASDAQ:PCTY) P/E ratio and reflect on what it tells us about the company’s share price. Based on the last twelve months, Paylocity Holding’s P/E ratio is 66.63. That is equivalent to an earnings yield of about 1.5%.
Check out our latest analysis for Paylocity Holding
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 Paylocity Holding:
P/E of 66.63 = $60.61 ÷ $0.91 (Based on the trailing twelve months to September 2018.)
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
Earnings growth rates have a big influence on P/E ratios. Earnings growth means that in the future the ‘E’ will be higher. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
It’s nice to see that Paylocity Holding grew EPS by a stonking 377% in the last year. And earnings per share have improved by 71% annually, over the last five years. I’d therefore be a little surprised if its P/E ratio was not relatively high.
How Does Paylocity Holding’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that Paylocity Holding has a higher P/E than the average (44) P/E for companies in the software industry.
Paylocity Holding’s P/E tells us that market participants think the company will perform better than its industry peers, going forward. The market is optimistic about the future, but that doesn’t guarantee future growth. So further research is always essential. I often monitor director buying and selling.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The ‘Price’ in P/E reflects the market capitalization of the company. That means it doesn’t take debt or cash into account. Theoretically, a business can improve its earnings (and produce a lower P/E in the future), by taking on debt (or spending its remaining cash).
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
Is Debt Impacting Paylocity Holding’s P/E?
Since Paylocity Holding holds net cash of US$85m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Verdict On Paylocity Holding’s P/E Ratio
Paylocity Holding trades on a P/E ratio of 66.6, which is multiples above the US market average of 17.9. Its net cash position supports a higher P/E ratio, as does its solid recent earnings growth. So it does not seem strange that the P/E is above average.
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 they key to an excellent investment decision.
Of course you might be able to find a better stock than Paylocity Holding. So you may wish to see this free collection of other companies that have grown earnings strongly.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.
