This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll look at Ingersoll-Rand Plc's (NYSE:IR) P/E ratio and reflect on what it tells us about the company's share price. Ingersoll-Rand has a P/E ratio of 23.04, based on the last twelve months. That corresponds to an earnings yield of approximately 4.3%.
How Do You Calculate Ingersoll-Rand's P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Ingersoll-Rand:
P/E of 23.04 = $127.82 ÷ $5.55 (Based on the trailing twelve months to September 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 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 Ingersoll-Rand's P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. As you can see below Ingersoll-Rand has a P/E ratio that is fairly close for the average for the machinery industry, which is 22.7.
Its P/E ratio suggests that Ingersoll-Rand shareholders think that in the future it will perform about the same as other companies in its industry classification. If the company has better than average prospects, then the market might be underestimating it. I would further inform my view by checking insider buying and selling., among other things.
How Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
Ingersoll-Rand saw earnings per share decrease by 14% last year. But it has grown its earnings per share by 15% per year over the last five years.
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. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on 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 Ingersoll-Rand's Debt Impact Its P/E Ratio?
Ingersoll-Rand has net debt worth 15% 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 Ingersoll-Rand's P/E Ratio
Ingersoll-Rand has a P/E of 23.0. That's higher than the average in its market, which is 18.2. With some debt but no EPS growth last year, the market has high expectations of future profits.
Investors have an opportunity when market expectations about a stock are wrong. 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 the key to an excellent investment decision.
You might be able to find a better buy than Ingersoll-Rand. 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.