This analysis is intended to introduce important early concepts to people who are starting to invest and want to learn about the link between company’s fundamentals and stock market performance.
B&G Foods Inc (NYSE:BGS) is currently trading at a trailing P/E of 9x, which is lower than the industry average of 17.8x. While this makes BGS appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. In this article, I will break down what the P/E ratio is, how to interpret it and what to watch out for.
Demystifying the P/E ratio
A common ratio used for relative valuation is the P/E ratio. By comparing a stock’s price per share to its earnings per share, we are able to see how much investors are paying for each dollar of the company’s earnings.
P/E Calculation for BGS
Price-Earnings Ratio = Price per share ÷ Earnings per share
BGS Price-Earnings Ratio = $25.82 ÷ $2.877 = 9x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as BGS, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use. BGS’s P/E of 9 is lower than its industry peers (17.8), which implies that each dollar of BGS’s earnings is being undervalued by investors. This multiple is a median of profitable companies of 24 Food companies in US including China Modern Agricultural Information, Amira Nature Foods and Hostess Brands. One could put it like this: the market is pricing BGS as if it is a weaker company than the average company in its industry.
Assumptions to watch out for
However, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to BGS. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you are comparing lower risk firms with BGS, then its P/E would naturally be lower than its peers, as investors would value those with lower risk at a higher price. The second assumption that must hold true is that the stocks we are comparing BGS to are fairly valued by the market. If this does not hold true, BGS’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
You may have already conducted fundamental analysis on the stock as a shareholder, so its current undervaluation could signal a good buying opportunity to increase your exposure to BGS. Now that you understand the ins and outs of the PE metric, you should know to bear in mind its limitations before you make an investment decision. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I urge you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for BGS’s future growth? Take a look at our free research report of analyst consensus for BGS’s outlook.
- Past Track Record: Has BGS been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of BGS’s historicals for more clarity.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
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 email@example.com.