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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 Clearfield, Inc.’s (NASDAQ:CLFD) P/E ratio and reflect on what it tells us about the company’s share price.
Clearfield has a P/E ratio of 38.54, based on the last twelve months.
In other words, at today’s prices, investors are paying $38.54 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 Clearfield:
P/E of 38.54 = $12.47 ÷ $0.32
(Based on the trailing twelve months to December 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 is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
How Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the ‘E’ in the equation.
That means unless the share price falls, the P/E will increase in a few years.
A higher P/E should indicate the stock is expensive relative to others — and that may encourage shareholders to sell.
Clearfield increased earnings per share by an impressive 12% over the last twelve months.
But earnings per share are down 8.4% per year over the last five years.
How Does Clearfield’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio.
You can see in the image below that the average P/E (27.8) for companies in the communications industry is lower than Clearfield’s P/E.
Its relatively high P/E ratio indicates that Clearfield shareholders think it will perform better than other companies in its industry classification.
The market is optimistic about the future, but that doesn’t guarantee future growth.
So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
Remember: P/E Ratios Don’t Consider The Balance Sheet
The ‘Price’ in P/E reflects the market capitalization of the company.
That means it doesn’t take debt or cash into account.
In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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 Clearfield’s P/E?
The extra options and safety that comes with Clearfield’s US$24m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Verdict On Clearfield’s P/E Ratio
Clearfield trades on a P/E ratio of 38.5, which is above the US market average of 16.8.
Its net cash position supports a higher P/E ratio, as does its solid recent earnings growth.
So it does not seem strange that the P/E is above average.
Investors have an opportunity when market expectations about a stock are wrong.
People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated.
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.
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.
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