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Should You Be Tempted To Sell Luminex Corporation (NASDAQ:LMNX) Because Of Its P/E Ratio?

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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we'll show how Luminex Corporation's (NASDAQ:LMNX) P/E ratio could help you assess the value on offer. Luminex has a price to earnings ratio of 55.18, based on the last twelve months. That means that at current prices, buyers pay $55.18 for every $1 in trailing yearly profits.

Check out our latest analysis for Luminex

How Do You Calculate A P/E Ratio?

The formula for price to earnings is:

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Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)

Or for Luminex:

P/E of 55.18 = $22.96 ÷ $0.42 (Based on the year to December 2018.)

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 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

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.

Luminex shrunk earnings per share by 38% over the last year. But EPS is up 19% over the last 5 years. And over the longer term (3 years) earnings per share have decreased 22% annually. This could justify a low P/E.

How Does Luminex's P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. As you can see below, Luminex has a higher P/E than the average company (34.5) in the life sciences industry.

NasdaqGS:LMNX Price Estimation Relative to Market, May 1st 2019
NasdaqGS:LMNX Price Estimation Relative to Market, May 1st 2019

Luminex'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.

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).

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 Luminex's Debt Impact Its P/E Ratio?

The extra options and safety that comes with Luminex's US$76m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.

The Bottom Line On Luminex's P/E Ratio

With a P/E ratio of 55.2, Luminex is expected to grow earnings very strongly in the years to come. 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 visual report on analyst forecasts could hold the key to an excellent investment decision.

You might be able to find a better buy than Luminex. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

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 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. Thank you for reading.