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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we’ll show how Matson, Inc.’s (NYSE:MATX) P/E ratio could help you assess the value on offer. Matson has a P/E ratio of 5.39, based on the last twelve months. In other words, at today’s prices, investors are paying $5.39 for every $1 in prior year profit.
Check out our latest analysis for Matson
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Matson:
P/E of 5.39 = $32.25 ÷ $5.98 (Based on the trailing twelve months to September 2018.)
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 Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. 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. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
It’s nice to see that Matson grew EPS by a stonking 202% in the last year. And its annual EPS growth rate over 5 years is 32%. So we’d generally expect it to have a relatively high P/E ratio.
How Does Matson’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 Matson has a lower P/E than the average (11) in the shipping industry classification.
Its relatively low P/E ratio indicates that Matson shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Matson, 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.
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. That means it doesn’t take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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.