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Here's What Tootsie Roll Industries, Inc.'s (NYSE:TR) P/E Is Telling Us

Simply Wall St

This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). To keep it practical, we'll show how Tootsie Roll Industries, Inc.'s (NYSE:TR) P/E ratio could help you assess the value on offer. Tootsie Roll Industries has a P/E ratio of 38.44, based on the last twelve months. That is equivalent to an earnings yield of about 2.6%.

See our latest analysis for Tootsie Roll Industries

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 Tootsie Roll Industries:

P/E of 38.44 = $37.000 ÷ $0.963 (Based on the trailing twelve months to December 2019.)

(Note: the above calculation results may not be precise due to rounding.)

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.

Does Tootsie Roll Industries Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio indicates whether the market has higher or lower expectations of a company. As you can see below, Tootsie Roll Industries has a higher P/E than the average company (20.6) in the food industry.

NYSE:TR Price Estimation Relative to Market April 14th 2020
NYSE:TR Price Estimation Relative to Market April 14th 2020

That means that the market expects Tootsie Roll Industries will outperform other companies in its industry. Clearly the market expects growth, but it isn't guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.

How Growth Rates Impact P/E Ratios

If earnings fall then in the future the 'E' will be lower. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. Then, a higher P/E might scare off shareholders, pushing the share price down.

It's great to see that Tootsie Roll Industries grew EPS by 15% in the last year. And it has bolstered its earnings per share by 1.9% per year over the last five years. With that performance, you might expect an above average P/E ratio.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. Thus, the metric does not reflect cash or debt held by the company. 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 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.

Is Debt Impacting Tootsie Roll Industries's P/E?

Since Tootsie Roll Industries holds net cash of US$231m, it can spend on growth, justifying a higher P/E ratio than otherwise.

The Bottom Line On Tootsie Roll Industries's P/E Ratio

Tootsie Roll Industries trades on a P/E ratio of 38.4, which is above its market average of 13.9. With cash in the bank the company has plenty of growth options -- and it is already on the right track. So it does not seem strange that the P/E is above average.

Investors should be looking to buy stocks that the market is wrong about. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. We don't have analyst forecasts, but you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.

You might be able to find a better buy than Tootsie Roll Industries. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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.

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.