The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we’ll show how National Beverage Corp.’s (NASDAQ:FIZZ) P/E ratio could help you assess the value on offer. National Beverage has a P/E ratio of 19.01, based on the last twelve months. That means that at current prices, buyers pay $19.01 for every $1 in trailing yearly profits.
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for National Beverage:
P/E of 19.01 = $68.27 ÷ $3.59 (Based on the year to October 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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
Probably the most important factor in determining what P/E a company trades on is the earnings growth. Earnings growth means that in the future the ‘E’ will be higher. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
National Beverage increased earnings per share by a whopping 33% last year. And earnings per share have improved by 31% annually, over the last five years. So we’d generally expect it to have a relatively high P/E ratio.
How Does National Beverage’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. We can see in the image below that the average P/E (25.8) for companies in the beverage industry is higher than National Beverage’s P/E.
National Beverage’s P/E tells us that market participants think it will not fare as well as its peers in the same 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.
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. 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 taking on debt (or spending its remaining 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 National Beverage’s P/E?
National Beverage has net cash of US$250m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Bottom Line On National Beverage’s P/E Ratio
National Beverage has a P/E of 19. That’s higher than the average in the US market, which is 17.4. With cash in the bank the company has plenty of growth options — and it is already on the right track. Therefore it seems reasonable that the market would have relatively high expectations of the company
When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. 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: National Beverage 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 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.