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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll look at Coca-Cola Amatil Limited's (ASX:CCL) P/E ratio and reflect on what it tells us about the company's share price. Coca-Cola Amatil has a price to earnings ratio of 15.06, based on the last twelve months. That corresponds to an earnings yield of approximately 6.6%.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Coca-Cola Amatil:
P/E of 15.06 = A$8.35 ÷ A$0.55 (Based on the year to December 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each A$1 of company earnings. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
Coca-Cola Amatil saw earnings per share decrease by 7.1% last year. But EPS is up 23% over the last 5 years.
How Does Coca-Cola Amatil's P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. We can see in the image below that the average P/E (23) for companies in the beverage industry is higher than Coca-Cola Amatil's P/E.
Its relatively low P/E ratio indicates that Coca-Cola Amatil shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
Remember: P/E Ratios Don't Consider The Balance Sheet
Don't forget that the P/E ratio considers market capitalization. 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 taking on debt (or spending its remaining cash).
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
How Does Coca-Cola Amatil's Debt Impact Its P/E Ratio?
Net debt totals 23% of Coca-Cola Amatil's market cap. That's enough debt to impact the P/E ratio a little; so keep it in mind if you're comparing it to companies without debt.
The Verdict On Coca-Cola Amatil's P/E Ratio
Coca-Cola Amatil's P/E is 15.1 which is about average (16) in the AU market. When you consider the lack of EPS growth last year (along with some debt), it seems the market is optimistic about the future for the business.
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 be able to find a better stock than Coca-Cola Amatil. So you may wish to see this free collection of other companies that have grown earnings strongly.
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 email@example.com. 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.