The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we’ll show how PRA Health Sciences, Inc.’s (NASDAQ:PRAH) P/E ratio could help you assess the value on offer. Based on the last twelve months, PRA Health Sciences’s P/E ratio is 44.57. That is equivalent to an earnings yield of about 2.2%.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for PRA Health Sciences:
P/E of 44.57 = $106.98 ÷ $2.4 (Based on the trailing twelve months to December 2018.)
Is A High P/E Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the ‘E’ increases, over time. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
PRA Health Sciences increased earnings per share by a whopping 72% last year. And earnings per share have improved by 60% annually, over the last five years. I’d therefore be a little surprised if its P/E ratio was not relatively high.
How Does PRA Health Sciences’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. The image below shows that PRA Health Sciences has a higher P/E than the average (34.5) P/E for companies in the life sciences industry.
Its relatively high P/E ratio indicates that PRA Health Sciences 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 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
The ‘Price’ in P/E reflects the market capitalization of the company. 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 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.
PRA Health Sciences’s Balance Sheet
PRA Health Sciences has net debt worth 13% of its market capitalization. This could bring some additional risk, and reduce the number of investment options for management; worth remembering if you compare its P/E to businesses without debt.
The Bottom Line On PRA Health Sciences’s P/E Ratio
PRA Health Sciences has a P/E of 44.6. That’s higher than the average in the US market, which is 17.6. While the company does use modest debt, its recent earnings growth is impressive. So it is not surprising the market is probably extrapolating recent growth well into the future, reflected in the relatively high P/E ratio.
Investors have an opportunity when market expectations about a stock are wrong. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
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