Is Ardagh Group S.A.’s (NYSE:ARD) High P/E Ratio A Problem For Investors?
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 Ardagh Group S.A.’s (NYSE:ARD) P/E ratio could help you assess the value on offer. Based on the last twelve months, Ardagh Group’s P/E ratio is 34.08. That corresponds to an earnings yield of approximately 2.9%.
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How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Ardagh Group:
P/E of 34.08 = $11.93 ÷ $0.35 (Based on the trailing twelve months to September 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. That isn’t necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
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. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. Then, a lower P/E should attract more buyers, pushing the share price up.
It’s nice to see that Ardagh Group grew EPS by a stonking 238% in the last year. And its annual EPS growth rate over 5 years is 187%. I’d therefore be a little surprised if its P/E ratio was not relatively high.
How Does Ardagh Group’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. You can see in the image below that the average P/E (19) for companies in the packaging industry is lower than Ardagh Group’s P/E.
Its relatively high P/E ratio indicates that Ardagh Group shareholders think it will perform better than other companies in its industry classification. The market is optimistic about the future, but that doesn’t guarantee future growth. So investors 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. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
Is Debt Impacting Ardagh Group’s P/E?
Ardagh Group has net debt worth a very significant 272% of its market capitalization. This is a relatively high level of debt, so the stock probably deserves a relatively low P/E ratio. Keep that in mind when comparing it to other companies.
The Verdict On Ardagh Group’s P/E Ratio
Ardagh Group trades on a P/E ratio of 34.1, which is above the US market average of 16.7. It’s good to see the recent earnings growth, although we note the company uses debt already. But if growth falters, the relatively high P/E ratio may prove to be unjustified.
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.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
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.
