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 Packaging Corporation of America's (NYSE:PKG) P/E ratio to inform your assessment of the investment opportunity. Packaging Corporation of America has a price to earnings ratio of 12.39, based on the last twelve months. In other words, at today's prices, investors are paying $12.39 for every $1 in prior year profit.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Packaging Corporation of America:
P/E of 12.39 = $103.73 ÷ $8.38 (Based on the year to June 2019.)
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 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 Does Packaging Corporation of America'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 Packaging Corporation of America has a lower P/E than the average (16.8) P/E for companies in the packaging industry.
Its relatively low P/E ratio indicates that Packaging Corporation of America shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Packaging Corporation of America, it's quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.
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. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. That means even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
Packaging Corporation of America's earnings per share grew by -7.5% in the last twelve months. And earnings per share have improved by 10% annually, over the last five years.
Remember: P/E Ratios Don't Consider The Balance Sheet
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. So it won't reflect the advantage of cash, or disadvantage of debt. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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.
Packaging Corporation of America's Balance Sheet
Packaging Corporation of America's net debt is 20% of its market cap. This could bring some additional risk, and reduce the number of investment options for management; worth remembering if you compare its P/E to businesses without debt.
The Verdict On Packaging Corporation of America's P/E Ratio
Packaging Corporation of America trades on a P/E ratio of 12.4, which is below the US market average of 18.0. The company does have a little debt, and EPS is moving in the right direction. The P/E ratio implies the market is cautious about longer term prospects.
Investors should be looking to buy stocks that the market is wrong about. 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 visual report on analyst forecasts could hold the key to an excellent investment decision.
But note: Packaging Corporation of America 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).
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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. Thank you for reading.