In This Article:
The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll look at Kennametal Inc.’s (NYSE:KMT) P/E ratio and reflect on what it tells us about the company’s share price. Kennametal has a P/E ratio of 13.57, based on the last twelve months. That corresponds to an earnings yield of approximately 7.4%.
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How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Kennametal:
P/E of 13.57 = $36.11 ÷ $2.66 (Based on the trailing twelve months to September 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. 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 Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. 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.
Kennametal increased earnings per share by a whopping 95% last year. And its annual EPS growth rate over 5 years is 10.0%. So we’d generally expect it to have a relatively high P/E ratio.
How Does Kennametal’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. If you look at the image below, you can see Kennametal has a lower P/E than the average (18.9) in the machinery industry classification.
Its relatively low P/E ratio indicates that Kennametal shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
Remember: P/E Ratios Don’t Consider The Balance Sheet
The ‘Price’ in P/E reflects the market capitalization of the company. 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).