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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll look at Amcor plc's (ASX:AMC) P/E ratio and reflect on what it tells us about the company's share price. Based on the last twelve months, Amcor's P/E ratio is 13.16. That corresponds to an earnings yield of approximately 7.6%.
How Do You Calculate Amcor's P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)
Or for Amcor:
P/E of 13.16 = $11.39 (Note: this is the share price in the reporting currency, namely, USD ) ÷ $0.87 (Based on the trailing twelve months to March 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each A$1 the company has earned over the last year. 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 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.
Amcor's earnings made like a rocket, taking off 59% last year. Even better, EPS is up 31% per year over three years. So we'd absolutely expect it to have a relatively high P/E ratio.
Does Amcor Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio indicates whether the market has higher or lower expectations of a company. As you can see below Amcor has a P/E ratio that is fairly close for the average for the packaging industry, which is 13.5.
Amcor's P/E tells us that market participants think its prospects are roughly in line with its industry. So if Amcor actually outperforms its peers going forward, that should be a positive for the share price. Further research into factors such asmanagement tenure, could help you form your own view on whether that is likely.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The 'Price' in P/E reflects the market capitalization of the company. 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.
How Does Amcor's Debt Impact Its P/E Ratio?
Amcor has net cash of US$130. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Verdict On Amcor's P/E Ratio
Amcor's P/E is 13.2 which is below average (15.8) in the AU market. It grew its EPS nicely over the last year, and the healthy balance sheet implies there is more potential for growth. The below average P/E ratio suggests that market participants don't believe the strong growth will continue. Because analysts are predicting more growth in the future, one might have expected to see a higher P/E ratio. You can taker closer look at the fundamentals, here.
Investors should be looking to buy stocks that the market is wrong about. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
But note: Amcor 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 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. Thank you for reading.