This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll look at Australian Vintage Ltd's (ASX:AVG) P/E ratio and reflect on what it tells us about the company's share price. What is Australian Vintage's P/E ratio? Well, based on the last twelve months it is 16.70. That means that at current prices, buyers pay A$16.70 for every A$1 in trailing yearly profits.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Australian Vintage:
P/E of 16.70 = AUD0.48 ÷ AUD0.03 (Based on the trailing twelve months to June 2019.)
Is A High P/E Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price'.
How Does Australian Vintage's P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. If you look at the image below, you can see Australian Vintage has a lower P/E than the average (24.1) in the beverage industry classification.
Australian Vintage's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Australian Vintage, it's quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
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. When earnings grow, the 'E' increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Australian Vintage saw earnings per share improve by -4.6% last year. In contrast, EPS has decreased by 11%, annually, over 5 years.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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 Australian Vintage's Debt Impact Its P/E Ratio?
Australian Vintage's net debt is 50% 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 Australian Vintage's P/E Ratio
Australian Vintage has a P/E of 16.7. That's below the average in the AU market, which is 18.6. It's good to see EPS growth in the last 12 months, but the debt on the balance sheet might be muting expectations.
Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
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.
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