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Why Standard Motor Products, Inc.'s (NYSE:SMP) High P/E Ratio Isn't Necessarily A Bad Thing

Simply Wall St
·4 mins read

Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll apply a basic P/E ratio analysis to Standard Motor Products, Inc.'s (NYSE:SMP), to help you decide if the stock is worth further research. Standard Motor Products has a price to earnings ratio of 13.44, based on the last twelve months. That means that at current prices, buyers pay $13.44 for every $1 in trailing yearly profits.

See our latest analysis for Standard Motor Products

How Do You Calculate A P/E Ratio?

The formula for P/E is:

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

Or for Standard Motor Products:

P/E of 13.44 = $41.470 ÷ $3.086 (Based on the year to December 2019.)

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

Is A High Price-to-Earnings Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. 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 Standard Motor Products Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio essentially measures market expectations of a company. As you can see below Standard Motor Products has a P/E ratio that is fairly close for the average for the auto components industry, which is 13.0.

NYSE:SMP Price Estimation Relative to Market April 27th 2020
NYSE:SMP Price Estimation Relative to Market April 27th 2020

That indicates that the market expects Standard Motor Products will perform roughly in line with other companies in its industry. The company could surprise by performing better than average, in the future. I would further inform my view by checking insider buying and selling., among other things.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the 'E' will be higher. 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.

Standard Motor Products increased earnings per share by an impressive 22% over the last twelve months. And earnings per share have improved by 6.0% annually, over the last five years. This could arguably justify a relatively high P/E ratio.

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

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. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.

So What Does Standard Motor Products's Balance Sheet Tell Us?

Net debt totals just 4.9% of Standard Motor Products's market cap. 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 Verdict On Standard Motor Products's P/E Ratio

Standard Motor Products trades on a P/E ratio of 13.4, which is fairly close to the US market average of 13.5. Given it has reasonable debt levels, and grew earnings strongly last year, the P/E indicates the market has doubts this growth can be sustained.

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 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.

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.