U.S. Markets closed

Despite Its High P/E Ratio, Is Coca-Cola HBC AG (LON:CCH) Still Undervalued?

Simply Wall St

Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at Coca-Cola HBC AG's (LON:CCH) P/E ratio and reflect on what it tells us about the company's share price. What is Coca-Cola HBC's P/E ratio? Well, based on the last twelve months it is 25.87. In other words, at today's prices, investors are paying £25.87 for every £1 in prior year profit.

See our latest analysis for Coca-Cola HBC

How Do I Calculate Coca-Cola HBC's Price To Earnings Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Share Price (in reporting currency) ÷ Earnings per Share (EPS)

Or for Coca-Cola HBC:

P/E of 25.87 = €31.46 (Note: this is the share price in the reporting currency, namely, EUR ) ÷ €1.22 (Based on the year to December 2018.)

Is A High P/E Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.'

Does Coca-Cola HBC Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio essentially measures market expectations of a company. The image below shows that Coca-Cola HBC has a P/E ratio that is roughly in line with the beverage industry average (24.9).

LSE:CCH Price Estimation Relative to Market, July 27th 2019

Coca-Cola HBC'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. Further research into factors such as insider buying and selling, could help you form your own view on whether that is likely.

How Growth Rates Impact P/E Ratios

Probably the most important factor in determining what P/E a company trades on is the earnings growth. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. And in that case, the P/E ratio itself will drop rather quickly. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Coca-Cola HBC saw earnings per share improve by -4.1% last year. And earnings per share have improved by 15% annually, over the last five years.

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. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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 Coca-Cola HBC's Balance Sheet Tell Us?

Coca-Cola HBC has net debt worth just 5.4% of its market capitalization. The market might award it a higher P/E ratio if it had net cash, but its unlikely this low level of net borrowing is having a big impact on the P/E multiple.

The Verdict On Coca-Cola HBC's P/E Ratio

Coca-Cola HBC trades on a P/E ratio of 25.9, which is above its market average of 16.3. Given the debt is only modest, and earnings are already moving in the right direction, it's not surprising that the market expects continued improvement.

Investors have an opportunity when market expectations about a stock are wrong. 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.

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.