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Despite Its High P/E Ratio, Is Maple Leaf Foods Inc. (TSE:MFI) Still Undervalued?

Simply Wall St

This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll show how you can use Maple Leaf Foods Inc.'s (TSE:MFI) P/E ratio to inform your assessment of the investment opportunity. Looking at earnings over the last twelve months, Maple Leaf Foods has a P/E ratio of 45.07. That is equivalent to an earnings yield of about 2.2%.

Check out our latest analysis for Maple Leaf Foods

How Do I Calculate A Price To Earnings Ratio?

The formula for price to earnings is:

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

Or for Maple Leaf Foods:

P/E of 45.07 = CA$29.96 ÷ CA$0.66 (Based on the trailing twelve months to June 2019.)

Is A High Price-to-Earnings 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.

How Does Maple Leaf Foods's P/E Ratio Compare To Its Peers?

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, Maple Leaf Foods has a higher P/E than the average company (20.6) in the food industry.

TSX:MFI Price Estimation Relative to Market, September 27th 2019

Maple Leaf Foods's P/E tells us that market participants think the company will perform better than its industry peers, going forward. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

How Growth Rates Impact P/E Ratios

When earnings fall, the 'E' decreases, over time. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.

Maple Leaf Foods shrunk earnings per share by 47% over the last year. And EPS is down 10% a year, over the last 3 years. This growth rate might warrant a low 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. Thus, the metric does not reflect cash or debt held by the company. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.

Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.

So What Does Maple Leaf Foods's Balance Sheet Tell Us?

Net debt totals 11% of Maple Leaf Foods's market cap. That's enough debt to impact the P/E ratio a little; so keep it in mind if you're comparing it to companies without debt.

The Verdict On Maple Leaf Foods's P/E Ratio

Maple Leaf Foods trades on a P/E ratio of 45.1, which is multiples above its market average of 14.1. With modest debt but no EPS growth in the last year, it's fair to say the P/E implies some optimism about future earnings, from the market.

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 report on the analyst consensus forecasts could help you make a master move on this stock.

You might be able to find a better buy than Maple Leaf Foods. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

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.