This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). To keep it practical, we’ll show how Reliance Steel & Aluminum Co.’s (NYSE:RS) P/E ratio could help you assess the value on offer. Reliance Steel & Aluminum has a P/E ratio of 5.93, based on the last twelve months. That means that at current prices, buyers pay $5.93 for every $1 in trailing yearly profits.

See our latest analysis for Reliance Steel & Aluminum

How Do I Calculate A Price To Earnings Ratio?

The formula for P/E is:

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

Or for Reliance Steel & Aluminum:

P/E of 5.93 = $69.47 ÷ $11.72 (Based on the year to September 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 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 Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. When earnings grow, the ‘E’ increases, over time. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.

Reliance Steel & Aluminum increased earnings per share by a whopping 128% last year. And its annual EPS growth rate over 5 years is 19%. So we’d generally expect it to have a relatively high P/E ratio.

How Does Reliance Steel & Aluminum’s P/E Ratio Compare To Its Peers?

The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that Reliance Steel & Aluminum has a lower P/E than the average (8.1) P/E for companies in the metals and mining industry.

Reliance Steel & Aluminum’s P/E tells us that market participants think it will not fare as well as its peers in the same industry. Many investors like to buy stocks when the market is pessimistic about their prospects. You should delve deeper. I like to check if company insiders have been buying or selling.

Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits

It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. That means it doesn’t take debt or cash into account. Theoretically, a business can improve its earnings (and produce a lower P/E in the future), by taking on debt (or spending its remaining cash).

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 Reliance Steel & Aluminum’s P/E?

Net debt totals 39% of Reliance Steel & Aluminum’s market cap. This is a reasonably significant level of debt — all else being equal you’d expect a much lower P/E than if it had net cash.

The Bottom Line On Reliance Steel & Aluminum’s P/E Ratio

Reliance Steel & Aluminum trades on a P/E ratio of 5.9, which is below the US market average of 15.6. The company hasn’t stretched its balance sheet, and earnings growth was good last year. The low P/E ratio suggests current market expectations are muted, implying these levels of growth will not continue.

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 visual report on analyst forecasts could hold they key to an excellent investment decision.

You might be able to find a better buy than Reliance Steel & Aluminum. 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).

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 editorial-team@simplywallst.com.