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Despite Its High P/E Ratio, Is Cogeco Inc. (TSE:CGO) Still Undervalued?

Simply Wall St

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 Cogeco Inc.'s (TSE:CGO) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Cogeco's P/E ratio is 40.70. That is equivalent to an earnings yield of about 2.5%.

View our latest analysis for Cogeco

How Do I Calculate A Price To Earnings Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)

Or for Cogeco:

P/E of 40.70 = CA$97.64 ÷ CA$2.40 (Based on the year to May 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 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.

Does Cogeco 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. You can see in the image below that the average P/E (14.1) for companies in the media industry is lower than Cogeco's P/E.

TSX:CGO Price Estimation Relative to Market, October 21st 2019

Its relatively high P/E ratio indicates that Cogeco 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.

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. 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. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

Cogeco shrunk earnings per share by 73% over the last year. And EPS is down 9.4% a year, over the last 5 years. This growth rate might warrant a below average P/E ratio.

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.

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).

Cogeco's Balance Sheet

Net debt totals a substantial 198% of Cogeco's market cap. If you want to compare its P/E ratio to other companies, you must keep in mind that these debt levels would usually warrant a relatively low P/E.

The Verdict On Cogeco's P/E Ratio

Cogeco trades on a P/E ratio of 40.7, which is above its market average of 13.7. With meaningful debt and a lack of recent earnings growth, the market has high expectations that the business will earn more in the future.

When the market is wrong about a stock, it gives savvy investors an opportunity. 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 visual report on analyst forecasts could hold the key to an excellent investment decision.

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.