Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at Natural Grocers by Vitamin Cottage, Inc.'s (NYSE:NGVC) P/E ratio and reflect on what it tells us about the company's share price. Looking at earnings over the last twelve months, Natural Grocers by Vitamin Cottage has a P/E ratio of 21.74. In other words, at today's prices, investors are paying $21.74 for every $1 in prior year profit.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Natural Grocers by Vitamin Cottage:
P/E of 21.74 = $9.13 ÷ $0.42 (Based on the trailing twelve months to September 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each $1 of company earnings. That isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.
Does Natural Grocers by Vitamin Cottage Have A Relatively High Or Low P/E For Its Industry?
We can get an indication of market expectations by looking at the P/E ratio. As you can see below Natural Grocers by Vitamin Cottage has a P/E ratio that is fairly close for the average for the consumer retailing industry, which is 22.0.
Natural Grocers by Vitamin Cottage's P/E tells us that market participants think its prospects are roughly in line with its industry. The company could surprise by performing better than average, in the future. Checking factors such as director buying and selling. could help you form your own view on if that will happen.
How Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
Natural Grocers by Vitamin Cottage shrunk earnings per share by 26% over the last year. And EPS is down 6.9% a year, over the last 5 years. This might lead to muted expectations.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don't forget that the P/E ratio considers market capitalization. That means it doesn't take debt or cash into account. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.
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.
So What Does Natural Grocers by Vitamin Cottage's Balance Sheet Tell Us?
The extra options and safety that comes with Natural Grocers by Vitamin Cottage's US$522k 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 Natural Grocers by Vitamin Cottage's P/E Ratio
Natural Grocers by Vitamin Cottage has a P/E of 21.7. That's higher than the average in its market, which is 18.3. The recent drop in earnings per share would make some investors cautious, but the healthy balance sheet means the company retains potential for future growth. If fails to eventuate, the current high P/E could prove to be temporary, as the share price falls.
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. Although we don't have analyst forecasts shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.
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.