This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll show how you can use General Mills, Inc.'s (NYSE:GIS) P/E ratio to inform your assessment of the investment opportunity. General Mills has a price to earnings ratio of 20.32, based on the last twelve months. That corresponds to an earnings yield of approximately 4.9%.
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How Do You Calculate General Mills's P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for General Mills:
P/E of 20.32 = $52.39 ÷ $2.58 (Based on the trailing twelve months to February 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
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. 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.
General Mills shrunk earnings per share by 32% over the last year. And EPS is down 1.7% a year, over the last 5 years. This might lead to muted expectations.
How Does General Mills's P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. We can see in the image below that the average P/E (23.7) for companies in the food industry is higher than General Mills's P/E.
This suggests that market participants think General Mills will underperform other companies in its industry. Since the market seems unimpressed with General Mills, it's quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
Remember: P/E Ratios Don't Consider The Balance Sheet
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. That means it doesn't take debt or cash into account. 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).
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.
Is Debt Impacting General Mills's P/E?
Net debt is 46% of General Mills's market cap. While that's enough to warrant consideration, it doesn't really concern us.
The Verdict On General Mills's P/E Ratio
General Mills trades on a P/E ratio of 20.3, which is above the US market average of 17.7. 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 report on the analyst consensus forecasts could help you make a master move on this stock.
But note: General Mills 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).
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.