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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 Amdocs Limited's (NASDAQ:DOX) P/E ratio and reflect on what it tells us about the company's share price. What is Amdocs's P/E ratio? Well, based on the last twelve months it is 22.64. That means that at current prices, buyers pay $22.64 for every $1 in trailing yearly profits.
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 Amdocs:
P/E of 22.64 = $54.32 ÷ $2.4 (Based on the year to December 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 necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
How Growth Rates Impact P/E Ratios
When earnings fall, the 'E' decreases, over time. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. Then, a higher P/E might scare off shareholders, pushing the share price down.
Amdocs's earnings per share fell by 24% in the last twelve months. And over the longer term (5 years) earnings per share have decreased 1.4% annually. This growth rate might warrant a below average P/E ratio.
Does Amdocs Have A Relatively High Or Low P/E For Its Industry?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Amdocs has a lower P/E than the average (32.8) P/E for companies in the it industry.
This suggests that market participants think Amdocs will underperform other companies in its industry. Since the market seems unimpressed with Amdocs, it's quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
Remember: P/E Ratios Don't Consider The Balance Sheet
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. 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 investing in growth. That means taking on debt (or spending its cash).
While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
Amdocs's Balance Sheet
Amdocs has net cash of US$459m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Verdict On Amdocs's P/E Ratio
Amdocs has a P/E of 22.6. That's higher than the average in the US market, which is 18.1. Falling earnings per share is probably keeping traditional value investors away, but the healthy balance sheet means the company retains potential for future growth. If fails to eventuate, the current high P/E could prove to be temporary, as the share price falls.
Investors should be looking to buy stocks that the market is wrong about. 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 report on the analyst consensus forecasts could help you make a master move on this stock.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
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 firstname.lastname@example.org. 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.