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Do You Know What KAR Auction Services, Inc.'s (NYSE:KAR) P/E Ratio Means?

The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll show how you can use KAR Auction Services, Inc.'s (NYSE:KAR) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, KAR Auction Services's P/E ratio is 9.39. That means that at current prices, buyers pay $9.39 for every $1 in trailing yearly profits.

See our latest analysis for KAR Auction Services

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 KAR Auction Services:

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P/E of 9.39 = $21.39 ÷ $2.28 (Based on the year to September 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each $1 of company earnings. 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.

Does KAR Auction Services Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio indicates whether the market has higher or lower expectations of a company. We can see in the image below that the average P/E (26.4) for companies in the commercial services industry is higher than KAR Auction Services's P/E.

NYSE:KAR Price Estimation Relative to Market, November 27th 2019
NYSE:KAR Price Estimation Relative to Market, November 27th 2019

This suggests that market participants think KAR Auction Services will underperform other companies in its industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the 'E' will be higher. 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.

KAR Auction Services increased earnings per share by an impressive 11% over the last twelve months. And its annual EPS growth rate over 5 years is 26%. With that performance, you might expect an above average P/E ratio.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

The 'Price' in P/E reflects the market capitalization of the company. So it won't reflect the advantage of cash, or disadvantage of debt. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on 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.

Is Debt Impacting KAR Auction Services's P/E?

KAR Auction Services's net debt is considerable, at 102% of its market cap. This level of debt justifies a relatively low P/E, so remain cognizant of the debt, if you're comparing it to other stocks.

The Bottom Line On KAR Auction Services's P/E Ratio

KAR Auction Services has a P/E of 9.4. That's below the average in the US market, which is 18.4. The company may have significant debt, but EPS growth was good last year. If it continues to grow, then the current low P/E may prove to be unjustified.

When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. 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 KAR Auction Services. 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).

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.

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. Thank you for reading.