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 Intuit Inc.’s (NASDAQ:INTU) P/E ratio could help you assess the value on offer. Based on the last twelve months, Intuit’s P/E ratio is 40.7. That means that at current prices, buyers pay $40.7 for every $1 in trailing yearly profits.
How Do I Calculate Intuit’s Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Intuit:
P/E of 40.7 = $197.49 ÷ $4.85 (Based on the trailing twelve months to October 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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
Earnings growth rates have a big influence on P/E ratios. When earnings grow, the ‘E’ increases, over time. 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.
Most would be impressed by Intuit earnings growth of 25% in the last year. And earnings per share have improved by 15% annually, over the last five years. This could arguably justify a relatively high P/E ratio.
How Does Intuit’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Intuit has a P/E ratio that is roughly in line with the software industry average (41.3).
That indicates that the market expects Intuit will perform roughly in line with other companies in its industry. If the company has better than average prospects, then the market might be underestimating it. I inform my view byby checking management tenure and remuneration, among other things.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don’t forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. 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).
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.
Is Debt Impacting Intuit’s P/E?
Intuit has net cash of US$907m. 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 Intuit’s P/E Ratio
Intuit has a P/E of 40.7. That’s higher than the average in the US market, which is 16.5. Its net cash position supports a higher P/E ratio, as does its solid recent earnings growth. Therefore it seems reasonable that the market would have relatively high expectations of the company
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 visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
Of course you might be able to find a better stock than Intuit. So you may wish to see this free collection of other companies that have grown earnings strongly.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.