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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 show how you can use Constellation Brands, Inc.'s (NYSE:STZ) P/E ratio to inform your assessment of the investment opportunity. What is Constellation Brands's P/E ratio? Well, based on the last twelve months it is 11.27. That corresponds to an earnings yield of approximately 8.9%.
How Do You Calculate Constellation Brands's P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Constellation Brands:
P/E of 11.27 = $203.23 ÷ $18.03 (Based on the year to February 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. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.'
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. Then, a lower P/E should attract more buyers, pushing the share price up.
In the last year, Constellation Brands grew EPS like Taylor Swift grew her fan base back in 2010; the 52% gain was both fast and well deserved. Even better, EPS is up 50% per year over three years. So we'd absolutely expect it to have a relatively high P/E ratio.
How Does Constellation Brands's P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. The image below shows that Constellation Brands has a lower P/E than the average (29.7) P/E for companies in the beverage industry.
This suggests that market participants think Constellation Brands will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. You should delve deeper. I like to check if company insiders have been buying or selling.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
Don't forget that the P/E ratio considers market capitalization. So it won't reflect the advantage of cash, or disadvantage of debt. 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.
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.
So What Does Constellation Brands's Balance Sheet Tell Us?
Constellation Brands has net debt equal to 35% of its market cap. You'd want to be aware of this fact, but it doesn't bother us.
The Verdict On Constellation Brands's P/E Ratio
Constellation Brands trades on a P/E ratio of 11.3, which is below the US market average of 18. The EPS growth last year was strong, and debt levels are quite reasonable. The low P/E ratio suggests current market expectations are muted, implying these levels of growth will not continue.
Investors have an opportunity when market expectations about a stock are wrong. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. 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: Constellation 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).
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.