The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll show how you can use Colgate-Palmolive Company's (NYSE:CL) P/E ratio to inform your assessment of the investment opportunity. Colgate-Palmolive has a price to earnings ratio of 24.61, based on the last twelve months. That corresponds to an earnings yield of approximately 4.1%.
How Do You Calculate Colgate-Palmolive's P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Colgate-Palmolive:
P/E of 24.61 = $66.54 ÷ $2.70 (Based on the trailing twelve months to September 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
Does Colgate-Palmolive Have A Relatively High Or Low P/E For Its Industry?
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 Colgate-Palmolive has a P/E ratio that is fairly close for the average for the household products industry, which is 25.0.
Colgate-Palmolive's P/E tells us that market participants think its prospects are roughly in line with its industry. The company could surprise by performing better than average, in the future. I would further inform my view by checking insider buying and selling., among other things.
How Growth Rates Impact P/E Ratios
When earnings fall, the 'E' decreases, over time. That means unless the share price falls, the P/E will increase in a few years. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
Most would be impressed by Colgate-Palmolive earnings growth of 12% in the last year. And it has bolstered its earnings per share by 3.3% per year over the last five years. This could arguably justify a relatively high P/E ratio.
Remember: P/E Ratios Don't Consider The Balance Sheet
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. Thus, the metric does not reflect cash or debt held by the company. 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).
While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
So What Does Colgate-Palmolive's Balance Sheet Tell Us?
Net debt totals 12% of Colgate-Palmolive's market cap. This could bring some additional risk, and reduce the number of investment options for management; worth remembering if you compare its P/E to businesses without debt.
The Verdict On Colgate-Palmolive's P/E Ratio
Colgate-Palmolive's P/E is 24.6 which is above average (18.3) in its market. The company is not overly constrained by its modest debt levels, and its recent EPS growth very solid. Therefore, it's not particularly surprising that it has a above average P/E ratio.
Investors should be looking to buy stocks that the market is wrong about. 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.
But note: Colgate-Palmolive may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
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 firstname.lastname@example.org. 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.