This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll look at Willamette Valley Vineyards, Inc.'s (NASDAQ:WVVI) P/E ratio and reflect on what it tells us about the company's share price. Willamette Valley Vineyards has a P/E ratio of 20.28, based on the last twelve months. That corresponds to an earnings yield of approximately 4.9%.
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 Willamette Valley Vineyards:
P/E of 20.28 = USD6.95 ÷ USD0.34 (Based on the trailing twelve months to September 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each USD1 the company has earned over the last year. 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.
How Does Willamette Valley Vineyards'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 Willamette Valley Vineyards has a lower P/E than the average (32.5) P/E for companies in the beverage industry.
Its relatively low P/E ratio indicates that Willamette Valley Vineyards shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Willamette Valley Vineyards, 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.
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.
Willamette Valley Vineyards's earnings per share fell by 24% in the last twelve months. And EPS is down 1.8% a year, over the last 3 years. This could justify a low P/E.
Remember: P/E Ratios Don't Consider The Balance Sheet
Don't forget that the P/E ratio considers market capitalization. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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.
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
Is Debt Impacting Willamette Valley Vineyards's P/E?
Willamette Valley Vineyards's net debt is 1.0% of its market cap. So it doesn't have as many options as it would with net cash, but its debt would not have much of an impact on its P/E ratio.
The Verdict On Willamette Valley Vineyards's P/E Ratio
Willamette Valley Vineyards's P/E is 20.3 which is about average (18.9) in the US market. With modest debt, and a lack of recent growth, it would seem the market is expecting improvement in earnings.
Investors should be looking to buy stocks that the market is wrong about. 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 you might want to assess this data-rich visualization 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 email@example.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.