This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll look at Hormel Foods Corporation's (NYSE:HRL) P/E ratio and reflect on what it tells us about the company's share price. Based on the last twelve months, Hormel Foods's P/E ratio is 24.41. That corresponds to an earnings yield of approximately 4.1%.
How Do I Calculate Hormel Foods's Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Hormel Foods:
P/E of 24.41 = $44.70 ÷ $1.83 (Based on the trailing twelve months to October 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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 Does Hormel 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. The image below shows that Hormel Foods has a P/E ratio that is roughly in line with the food industry average (24.4).
That indicates that the market expects Hormel Foods will perform roughly in line with other companies in its industry. The company could surprise by performing better than average, in the future. Further research into factors such as insider buying and selling, could help you form your own view on whether that is likely.
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. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
Hormel Foods's earnings per share fell by 3.9% in the last twelve months. But over the longer term (5 years) earnings per share have increased by 9.9%.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The 'Price' in P/E reflects the market capitalization of the company. 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.
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.
Is Debt Impacting Hormel Foods's P/E?
The extra options and safety that comes with Hormel Foods's US$438m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Bottom Line On Hormel Foods's P/E Ratio
Hormel Foods trades on a P/E ratio of 24.4, which is above its market average of 18.9. The recent drop in earnings per share might keep value investors away, but the relatively strong balance sheet will allow the company time to invest in growth. Clearly, the high P/E indicates shareholders think it will!
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 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.
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.
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. Thank you for reading.