The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll show how you can use Imperial Brands PLC's (LON:IMB) P/E ratio to inform your assessment of the investment opportunity. What is Imperial Brands's P/E ratio? Well, based on the last twelve months it is 13.12. That means that at current prices, buyers pay £13.12 for every £1 in trailing yearly profits.
How Do I Calculate Imperial Brands's Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Imperial Brands:
P/E of 13.12 = £21.4 ÷ £1.63 (Based on the year to March 2019.)
Is A High Price-to-Earnings Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing 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 Does Imperial Brands's P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. As you can see below Imperial Brands has a P/E ratio that is fairly close for the average for the tobacco industry, which is 13.6.
Its P/E ratio suggests that Imperial Brands shareholders think that in the future it will perform about the same as other companies in its industry classification. So if Imperial Brands actually outperforms its peers going forward, that should be a positive for the share price. I would further inform my view by checking insider buying and selling., among other things.
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. That means even if the current P/E is high, it will reduce over time if the share price stays flat. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Imperial Brands increased earnings per share by a whopping 27% last year. And it has bolstered its earnings per share by 19% per year over the last five years. I'd therefore be a little surprised if its P/E ratio was not relatively high.
Remember: P/E Ratios Don't Consider The Balance Sheet
Don't forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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.
Is Debt Impacting Imperial Brands's P/E?
Net debt totals 63% of Imperial Brands's market cap. This is enough debt that you'd have to make some adjustments before using the P/E ratio to compare it to a company with net cash.
The Verdict On Imperial Brands's P/E Ratio
Imperial Brands's P/E is 13.1 which is below average (16.3) in the GB market. While the EPS growth last year was strong, the significant debt levels reduce the number of options available to management. If the company can continue to grow earnings, then the current P/E may be unjustifiably low.
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 visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
But note: Imperial Brands 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).
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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.