Want to participate in a short research study? Help shape the future of investing tools and you could win a $250 gift card!
The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we'll show how CF Industries Holdings, Inc.'s (NYSE:CF) P/E ratio could help you assess the value on offer. CF Industries Holdings has a price to earnings ratio of 33.75, based on the last twelve months. That corresponds to an earnings yield of approximately 3.0%.
How Do I Calculate CF Industries Holdings's Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for CF Industries Holdings:
P/E of 33.75 = $46.52 ÷ $1.38 (Based on the year to March 2019.)
Is A High Price-to-Earnings 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 Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. That means even if the current P/E is low, it will increase over time if the share price stays flat. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
CF Industries Holdings shrunk earnings per share by 27% over the last year. And EPS is down 26% a year, over the last 5 years. This might lead to muted expectations.
How Does CF Industries Holdings'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, CF Industries Holdings has a higher P/E than the average company (18.9) in the chemicals industry.
CF Industries Holdings's P/E tells us that market participants think the company will perform better than its industry peers, going forward. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
Remember: P/E Ratios Don't Consider The Balance Sheet
The 'Price' in P/E reflects the market capitalization of the company. That means it doesn't take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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.
CF Industries Holdings's Balance Sheet
CF Industries Holdings's net debt equates to 39% of its market capitalization. While that's enough to warrant consideration, it doesn't really concern us.
The Bottom Line On CF Industries Holdings's P/E Ratio
CF Industries Holdings has a P/E of 33.7. That's higher than the average in the US market, which is 18.2. With modest debt but no EPS growth in the last year, it's fair to say the P/E implies some optimism about future earnings, from the market.
Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. 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.
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 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.