This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll look at ON Semiconductor Corporation's (NASDAQ:ON) P/E ratio and reflect on what it tells us about the company's share price. ON Semiconductor has a price to earnings ratio of 30.95, based on the last twelve months. In other words, at today's prices, investors are paying $30.95 for every $1 in prior year profit.
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 ON Semiconductor:
P/E of 30.95 = $24.07 ÷ $0.78 (Based on the year to September 2019.)
Is A High P/E 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 is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
How Does ON Semiconductor's P/E Ratio Compare To Its Peers?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. The image below shows that ON Semiconductor has a P/E ratio that is roughly in line with the semiconductor industry average (33.0).
Its P/E ratio suggests that ON Semiconductor shareholders think that in the future it will perform about the same as other companies in its industry classification. The company could surprise by performing better than average, in the future. Further research into factors such as insider buying and selling, could help you form your own view on whether that is likely.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. That means even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
ON Semiconductor shrunk earnings per share by 67% over the last year. But EPS is up 9.4% over the last 5 years.
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. Thus, the metric does not reflect cash or debt held by the company. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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.
How Does ON Semiconductor's Debt Impact Its P/E Ratio?
Net debt is 27% of ON Semiconductor's market cap. While that's enough to warrant consideration, it doesn't really concern us.
The Verdict On ON Semiconductor's P/E Ratio
ON Semiconductor's P/E is 30.9 which is above average (18.8) in its market. With modest debt but no EPS growth in the last year, it's fair to say the P/E implies some optimism about future earnings, from the market.
Investors have an opportunity when market expectations about a stock are wrong. 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 report on the analyst consensus forecasts could help you make a master move on this stock.
Of course you might be able to find a better stock than ON Semiconductor. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.
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