Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll show how you can use Intuitive Surgical, Inc.'s (NASDAQ:ISRG) P/E ratio to inform your assessment of the investment opportunity. Intuitive Surgical has a price to earnings ratio of 51.79, based on the last twelve months. That means that at current prices, buyers pay $51.79 for every $1 in trailing yearly profits.
How Do I Calculate Intuitive Surgical's Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Intuitive Surgical:
P/E of 51.79 = $591.15 ÷ $11.41 (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 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 Does Intuitive Surgical'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. You can see in the image below that the average P/E (45.4) for companies in the medical equipment industry is lower than Intuitive Surgical's P/E.
Intuitive Surgical'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 investors should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. When earnings grow, the 'E' increases, over time. And in that case, the P/E ratio itself will drop rather quickly. Then, a lower P/E should attract more buyers, pushing the share price up.
Intuitive Surgical's earnings made like a rocket, taking off 61% last year. The sweetener is that the annual five year growth rate of 24% is also impressive. So I'd be surprised if the P/E ratio was not above average.
Remember: P/E Ratios Don't Consider The Balance Sheet
Don't forget that the P/E ratio considers market capitalization. In other words, it does not consider any debt or cash that the company may have on the balance sheet. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
Is Debt Impacting Intuitive Surgical's P/E?
The extra options and safety that comes with Intuitive Surgical's US$2.9b 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 Intuitive Surgical's P/E Ratio
Intuitive Surgical's P/E is 51.8 which is above average (18.9) in its market. The excess cash it carries is the gravy on top its fast EPS growth. So based on this analysis we'd expect Intuitive Surgical to have a high P/E ratio.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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.
You might be able to find a better buy than Intuitive Surgical. 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).
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