Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at Archer-Daniels-Midland Company's (NYSE:ADM) P/E ratio and reflect on what it tells us about the company's share price. Archer-Daniels-Midland has a P/E ratio of 17.89, based on the last twelve months. That corresponds to an earnings yield of approximately 5.6%.
How Do You Calculate Archer-Daniels-Midland's P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Archer-Daniels-Midland:
P/E of 17.89 = $41.79 ÷ $2.34 (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. 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 Archer-Daniels-Midland Have A Relatively High Or Low P/E For Its Industry?
We can get an indication of market expectations by looking at the P/E ratio. We can see in the image below that the average P/E (26.5) for companies in the food industry is higher than Archer-Daniels-Midland's P/E.
Its relatively low P/E ratio indicates that Archer-Daniels-Midland shareholders think it will struggle to do as well as other companies in its industry classification. Many investors like to buy stocks when the market is pessimistic about their prospects. You should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
When earnings fall, the 'E' decreases, over time. That means even if the current P/E is low, it will increase over time if the share price stays flat. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
Archer-Daniels-Midland shrunk earnings per share by 32% over the last year. And it has shrunk its earnings per share by 1.4% per year over the last five years. This could justify a pessimistic P/E.
Remember: P/E Ratios Don't Consider The Balance Sheet
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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.
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.
Archer-Daniels-Midland's Balance Sheet
Net debt is 37% of Archer-Daniels-Midland's market cap. While that's enough to warrant consideration, it doesn't really concern us.
The Verdict On Archer-Daniels-Midland's P/E Ratio
Archer-Daniels-Midland's P/E is 17.9 which is about average (18.1) in the US market. With modest debt, and a lack of recent growth, it would seem the market is expecting improvement in earnings.
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 report on the analyst consensus forecasts could help you make a master move on this stock.
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.
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If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.