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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll show how you can use Electromed, Inc.'s (NYSEMKT:ELMD) P/E ratio to inform your assessment of the investment opportunity. Electromed has a price to earnings ratio of 27.63, based on the last twelve months. That means that at current prices, buyers pay $27.63 for every $1 in trailing yearly profits.
See our latest analysis for Electromed
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Electromed:
P/E of 27.63 = $6.55 ÷ $0.24 (Based on the trailing twelve months to June 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.
How Does Electromed'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 Electromed has a lower P/E than the average (40.5) P/E for companies in the medical equipment industry.
Its relatively low P/E ratio indicates that Electromed shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Electromed, it's quite possible it could surprise on the upside. 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
When earnings fall, the 'E' decreases, over time. That means unless the share price falls, the P/E will increase in a few years. Then, a higher P/E might scare off shareholders, pushing the share price down.
Electromed saw earnings per share improve by -6.3% last year. But earnings per share are down 4.5% per year over the last three years.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
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.
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 Electromed's P/E?
Electromed has net cash of US$7.8m. This is fairly high at 14% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.