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Why TAL Education Group's (NYSE:TAL) High P/E Ratio Isn't Necessarily A Bad Thing

Simply Wall St

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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll look at TAL Education Group's (NYSE:TAL) P/E ratio and reflect on what it tells us about the company's share price. TAL Education Group has a price to earnings ratio of 55.71, based on the last twelve months. That is equivalent to an earnings yield of about 1.8%.

View our latest analysis for TAL Education Group

How Do You Calculate TAL Education Group's P/E Ratio?

The formula for P/E is:

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

Or for TAL Education Group:

P/E of 55.71 = $35.9 ÷ $0.64 (Based on the year to February 2019.)

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 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 Does TAL Education Group's P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. The image below shows that TAL Education Group has a higher P/E than the average (24.9) P/E for companies in the consumer services industry.

NYSE:TAL Price Estimation Relative to Market, July 15th 2019

That means that the market expects TAL Education Group will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should delve deeper. I like to check if company insiders have been buying or selling.

How Growth Rates Impact P/E Ratios

Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. 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. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

TAL Education Group's earnings made like a rocket, taking off 70% last year. The sweetener is that the annual five year growth rate of 38% is also impressive. With that kind of growth rate we would generally expect a high P/E ratio.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

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. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).

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.

How Does TAL Education Group's Debt Impact Its P/E Ratio?

Since TAL Education Group holds net cash of US$1.3b, it can spend on growth, justifying a higher P/E ratio than otherwise.

The Bottom Line On TAL Education Group's P/E Ratio

TAL Education Group's P/E is 55.7 which suggests the market is more focussed on the future opportunity rather than the current level of earnings. Its net cash position is the cherry on top of its superb EPS growth. So based on this analysis we'd expect TAL Education Group to have a high P/E ratio.

Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.

But note: TAL Education Group may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

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.