Yahoo Finance Despite Its High P/E Ratio, Is Smiths Group plc (LON:SMIN) Still Undervalued?
This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). To keep it practical, we'll show how Smiths Group plc's (LON:SMIN) P/E ratio could help you assess the value on offer. Looking at earnings over the last twelve months, Smiths Group has a P/E ratio of 45.14. That means that at current prices, buyers pay £45.14 for every £1 in trailing yearly profits.
Check out our latest analysis for Smiths Group
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 Smiths Group:
P/E of 45.14 = £15.96 ÷ £0.35 (Based on the trailing twelve months to July 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. That isn't necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
How Does Smiths Group's P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. As you can see below, Smiths Group has a higher P/E than the average company (19.9) in the industrials industry.
Smiths Group's P/E tells us that market participants think the company will perform better than its industry peers, going forward. The market is optimistic about the future, but that doesn't guarantee future growth. So further research is always essential. I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
If earnings fall then in the future the 'E' will be lower. That means unless the share price falls, the P/E will increase in a few years. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
Smiths Group increased earnings per share by an impressive 20% over the last twelve months. But earnings per share are down 9.8% per year over the last five years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. Thus, the metric does not reflect cash or debt held by the company. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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.
Is Debt Impacting Smiths Group's P/E?
Smiths Group's net debt is 19% of its market cap. It would probably deserve a higher P/E ratio if it was net cash, since it would have more options for growth.
The Verdict On Smiths Group's P/E Ratio
Smiths Group's P/E is 45.1 which is above average (17.2) in its market. Its debt levels do not imperil its balance sheet and it is growing EPS strongly. So on this analysis it seems reasonable that its P/E ratio is above average.
Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
But note: Smiths Group may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
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.
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. Thank you for reading.
