Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at Aramark's (NYSE:ARMK) P/E ratio and reflect on what it tells us about the company's share price. What is Aramark's P/E ratio? Well, based on the last twelve months it is 24.26. That corresponds to an earnings yield of approximately 4.1%.
How Do I Calculate Aramark's Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Aramark:
P/E of 24.26 = $44.08 ÷ $1.82 (Based on the trailing twelve months 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 Aramark'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. As you can see below Aramark has a P/E ratio that is fairly close for the average for the hospitality industry, which is 24.5.
Aramark's P/E tells us that market participants think its prospects are roughly in line with its industry. So if Aramark actually outperforms its peers going forward, that should be a positive for the share price. Checking factors such as director buying and selling. could help you form your own view on if that will happen.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. Earnings growth means that in the future the 'E' will be higher. That means even if the current P/E is high, it will reduce over time if the share price stays flat. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Aramark saw earnings per share decrease by 21% last year. But EPS is up 22% over the last 5 years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. So it won't reflect the advantage of cash, or disadvantage of debt. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).
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).
How Does Aramark's Debt Impact Its P/E Ratio?
Net debt totals 57% of Aramark'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 Aramark's P/E Ratio
Aramark trades on a P/E ratio of 24.3, which is above its market average of 18.8. With relatively high debt, and no earnings per share growth over twelve months, it's safe to say the market believes the company will improve its earnings growth in the future.
Investors should be looking to buy stocks that the market is wrong about. 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 visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
You might be able to find a better buy than Aramark. 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 email@example.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.
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