The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll look at Brown-Forman Corporation’s (NYSE:BF.B) P/E ratio and reflect on what it tells us about the company’s share price. Based on the last twelve months, Brown-Forman’s P/E ratio is 31.81. That corresponds to an earnings yield of approximately 3.1%.
How Do You Calculate Brown-Forman’s P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Brown-Forman:
P/E of 31.81 = $48.92 ÷ $1.54 (Based on the year to July 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each $1 the company has earned over the last year. That isn’t necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
How Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the ‘E’ in the equation. 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.
Brown-Forman increased earnings per share by 5.4% last year. And it has bolstered its earnings per share by 8.0% per year over the last five years.
How Does Brown-Forman’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. As you can see below, Brown-Forman has a higher P/E than the average company (27.6) in the beverage industry.
Its relatively high P/E ratio indicates that Brown-Forman shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn’t guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
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. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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).
Is Debt Impacting Brown-Forman’s P/E?
Net debt totals just 9.7% of Brown-Forman’s market cap. The market might award it a higher P/E ratio if it had net cash, but its unlikely this low level of net borrowing is having a big impact on the P/E multiple.
The Verdict On Brown-Forman’s P/E Ratio
Brown-Forman’s P/E is 31.8 which is above average (18.2) in the US market. With debt at prudent levels and improving earnings, it’s fair to say the market expects steady progress 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 report on the analyst consensus forecasts could help you make a master move on this stock.
But note: Brown-Forman 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).
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at email@example.com.