This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). To keep it practical, we'll show how Emerson Electric Co.'s (NYSE:EMR) P/E ratio could help you assess the value on offer. What is Emerson Electric's P/E ratio? Well, based on the last twelve months it is 19.74. That corresponds to an earnings yield of approximately 5.1%.
How Do I Calculate Emerson Electric's Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Emerson Electric:
P/E of 19.74 = $70.23 ÷ $3.56 (Based on the year to June 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each $1 the company has earned over the last year. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
Does Emerson Electric Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. The image below shows that Emerson Electric has a higher P/E than the average (15.4) P/E for companies in the electrical industry.
Its relatively high P/E ratio indicates that Emerson Electric 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
Probably the most important factor in determining what P/E a company trades on is the earnings growth. When earnings grow, the 'E' increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Emerson Electric's earnings per share grew by -8.5% in the last twelve months. And earnings per share have improved by 14% annually, over the last three years.
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. So it won't reflect the advantage of cash, or disadvantage of debt. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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).
How Does Emerson Electric's Debt Impact Its P/E Ratio?
Emerson Electric has net debt worth 11% of its market capitalization. That's enough debt to impact the P/E ratio a little; so keep it in mind if you're comparing it to companies without debt.
The Bottom Line On Emerson Electric's P/E Ratio
Emerson Electric's P/E is 19.7 which is above average (17.8) in its market. With modest debt relative to its size, and modest earnings growth, the market is likely expecting sustained long-term growth, if not a near-term improvement.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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 visual report on analyst forecasts could hold the key to an excellent investment decision.
You might be able to find a better buy than Emerson Electric. 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).
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If you spot an error that warrants correction, please contact the editor at email@example.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.