Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. To keep it practical, we'll show how Ag Growth International Inc.'s (TSE:AFN) P/E ratio could help you assess the value on offer. Looking at earnings over the last twelve months, Ag Growth International has a P/E ratio of 76.79. That means that at current prices, buyers pay CA$76.79 for every CA$1 in trailing yearly profits.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Ag Growth International:
P/E of 76.79 = CAD46.10 ÷ CAD0.60 (Based on the year to September 2019.)
Is A High Price-to-Earnings 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.
How Does Ag Growth International'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. The image below shows that Ag Growth International has a higher P/E than the average (30.2) P/E for companies in the machinery industry.
Its relatively high P/E ratio indicates that Ag Growth International shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn't guaranteed. So further research is always essential. I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
If earnings fall then in the future the 'E' will be lower. That means unless the share price falls, the P/E will increase in a few years. Then, a higher P/E might scare off shareholders, pushing the share price down.
Ag Growth International's earnings per share fell by 74% in the last twelve months. And it has shrunk its earnings per share by 20% per year over the last five years. This might lead to muted expectations.
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. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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).
How Does Ag Growth International's Debt Impact Its P/E Ratio?
Ag Growth International's net debt is 88% of its market cap. If you want to compare its P/E ratio to other companies, you should absolutely keep in mind it has significant borrowings.
The Verdict On Ag Growth International's P/E Ratio
With a P/E ratio of 76.8, Ag Growth International is expected to grow earnings very strongly in the years to come. With significant debt and no EPS growth last year, shareholders are betting on an improvement in earnings from the company.
When the market is wrong about a stock, it gives savvy investors an opportunity. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. 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 be able to find a better stock than Ag Growth International. So you may wish to see this free collection of other companies that have grown earnings strongly.
If you spot an error that warrants correction, please contact the editor at email@example.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.
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