This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll look at Freeport-McMoRan Inc’s (NYSE:FCX) P/E ratio and reflect on what it tells us about the company’s share price. Freeport-McMoRan has a P/E ratio of 5.5, based on the last twelve months. That is equivalent to an earnings yield of about 18%.
How Do I Calculate Freeport-McMoRan’s Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Freeport-McMoRan:
P/E of 5.5 = $11.97 ÷ $2.18 (Based on the year to September 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each $1 the company has earned over the last year. 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 Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the ‘E’ increases, over time. That means unless the share price increases, the P/E will reduce in a few years. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
It’s nice to see that Freeport-McMoRan grew EPS by a stonking 201% in the last year. And earnings per share have improved by 1.4% annually, over the last five years. So we’d generally expect it to have a relatively high P/E ratio.
How Does Freeport-McMoRan’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. The image below shows that Freeport-McMoRan has a lower P/E than the average (10.3) P/E for companies in the metals and mining industry.
This suggests that market participants think Freeport-McMoRan will underperform other companies in its industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The ‘Price’ in P/E reflects the market capitalization of the company. That means it doesn’t take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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.
Freeport-McMoRan’s Balance Sheet
Freeport-McMoRan has net debt worth 37% of its market capitalization. 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 Bottom Line On Freeport-McMoRan’s P/E Ratio
Freeport-McMoRan trades on a P/E ratio of 5.5, which is below the US market average of 18. The company does have a little debt, and EPS growth was good last year. If the company can continue to grow earnings, then the current P/E may be unjustifiably low.
When the market is wrong about a stock, it gives savvy investors an opportunity. As value investor Benjamin Graham famously said, ‘In the short run, the market is a voting machine but in the long run, it is a weighing machine.’ 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.
Of course you might be able to find a better stock than Freeport-McMoRan. So you may wish to see this free collection of other companies that have grown earnings strongly.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.