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 Hurco Companies Inc’s ( NASDAQ:HURC ) P/E ratio could help you assess the value on offer. Hurco Companies has a price to earnings ratio of 13.17 , based on the last twelve months. That corresponds to an earnings yield of approximately 7.6%.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Hurco Companies:
P/E of 13.17 = $38.96 ÷ $2.96 (Based on the trailing twelve months to July 2018.)
Is A High P/E Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each $1 of company earnings. All else being equal, it’s better to pay a low price — but as Warren Buffett said, ‘It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.’
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. Earnings growth means that in the future the ‘E’ will be higher. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. Then, a lower P/E should attract more buyers, pushing the share price up.
Hurco Companies increased earnings per share by a whopping 72% last year. And earnings per share have improved by 7.9% annually, over the last five years. So we’d generally expect it to have a relatively high P/E ratio.
How Does Hurco Companies’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. We can see in the image below that the average P/E (19.2) for companies in the machinery industry is higher than Hurco Companies’s P/E.
Hurco Companies’s P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Hurco Companies, it’s quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling .
Remember: P/E Ratios Don’t Consider The Balance Sheet
Don’t forget that the P/E ratio considers market capitalization. That means it doesn’t take debt or cash into account. Theoretically, a business can improve its earnings (and produce a lower P/E in the future), by taking on debt (or spending its remaining 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.
Hurco Companies’s Balance Sheet
Hurco Companies has net cash of US$76m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Bottom Line On Hurco Companies’s P/E Ratio
Hurco Companies’s P/E is 13.2 which is below average (17.9) in the US market. Not only should the net cash position reduce risk, but the recent growth has been impressive. The below average P/E ratio suggests that market participants don’t believe the strong growth will continue.
Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. Although we don’t have analyst forecasts, shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
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.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com .