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Why Fastenal Company's (NASDAQ:FAST) High P/E Ratio Isn't Necessarily A Bad Thing

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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 Fastenal Company's ( NASDAQ:FAST ) P/E ratio and reflect on what it tells us about the company's share price. What is Fastenal's P/E ratio? Well, based on the last twelve months it is 23.18. In other words, at today's prices, investors are paying $23.18 for every $1 in prior year profit.

Check out our latest analysis for Fastenal

How Do I Calculate Fastenal's Price To Earnings Ratio?

The formula for price to earnings is:

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

Or for Fastenal:

P/E of 23.18 = $30.95 ÷ $1.34 (Based on the trailing twelve months to June 2019.)

Is A High P/E Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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.'

Does Fastenal 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, Fastenal has a higher P/E than the average company (17.4) in the trade distributors industry.

NasdaqGS:FAST Price Estimation Relative to Market, July 15th 2019

That means that the market expects Fastenal will outperform other companies in its industry. 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

Earnings growth rates have a big influence on P/E ratios. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

Fastenal increased earnings per share by an impressive 13% over the last twelve months. And earnings per share have improved by 11% annually, over the last five years. With that performance, you might expect an above average P/E ratio.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

Don't forget that the P/E ratio considers market capitalization. So it won't reflect the advantage of cash, or disadvantage of debt. 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 spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.

How Does Fastenal's Debt Impact Its P/E Ratio?

Fastenal's net debt is 1.8% of its market cap. So it doesn't have as many options as it would with net cash, but its debt would not have much of an impact on its P/E ratio.

The Verdict On Fastenal's P/E Ratio

Fastenal's P/E is 23.2 which is above average (18) in its market. While the company does use modest debt, its recent earnings growth is very good. Therefore, it's not particularly surprising that it has a above average P/E ratio.

When the market is wrong about a stock, it gives savvy investors an opportunity. 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.

Of course you might be able to find a better stock than Fastenal . So you may wish to see this free collection of other companies that have grown earnings strongly.

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.