Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll apply a basic P/E ratio analysis to KLA Corporation's (NASDAQ:KLAC), to help you decide if the stock is worth further research. Based on the last twelve months, KLA's P/E ratio is 19.06. That is equivalent to an earnings yield of about 5.2%.

View our latest analysis for KLA

How Do I Calculate KLA's Price To Earnings Ratio?

The formula for P/E is:

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

Or for KLA:

P/E of 19.06 = $143.57 ÷ $7.53 (Based on the year to June 2019.)

Is A High Price-to-Earnings 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 KLA's P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. We can see in the image below that the average P/E (27.4) for companies in the semiconductor industry is higher than KLA's P/E.

KLA's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with KLA, it's quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

Notably, KLA grew EPS by a whopping 47% in the last year. And its annual EPS growth rate over 5 years is 17%. So we'd generally expect it to have a relatively high P/E ratio.

Remember: P/E Ratios Don't Consider The Balance Sheet

The 'Price' in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. 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.

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.

So What Does KLA's Balance Sheet Tell Us?

KLA's net debt is 7.4% of its market cap. So it doesn't have as many options as it would with net cash, but its debt would not have much of an impact on its P/E ratio.

The Verdict On KLA's P/E Ratio

KLA's P/E is 19.1 which is above average (17.4) in its market. The company is not overly constrained by its modest debt levels, and its recent EPS growth is nothing short of stand-out. So to be frank we are not surprised it has a high P/E ratio.

When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.

Of course you might be able to find a better stock than KLA. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.

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. Thank you for reading.