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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.
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).