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Should You Be Tempted To Sell Clean Seas Seafood Limited (ASX:CSS) Because Of Its P/E Ratio?

Simply Wall St

This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to Clean Seas Seafood Limited's (ASX:CSS), to help you decide if the stock is worth further research. Clean Seas Seafood has a price to earnings ratio of 40.94, based on the last twelve months. In other words, at today's prices, investors are paying A$40.94 for every A$1 in prior year profit.

View our latest analysis for Clean Seas Seafood

How Do You Calculate A P/E Ratio?

The formula for P/E is:

Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)

Or for Clean Seas Seafood:

P/E of 40.94 = A$0.71 ÷ A$0.02 (Based on the year to June 2019.)

Is A High P/E Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. 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 Clean Seas Seafood's P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. As you can see below, Clean Seas Seafood has a higher P/E than the average company (26.6) in the food industry.

ASX:CSS Price Estimation Relative to Market, November 23rd 2019

Its relatively high P/E ratio indicates that Clean Seas Seafood shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn't guaranteed. So further research is always essential. I often monitor director buying and 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. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. Then, a lower P/E should attract more buyers, pushing the share price up.

Clean Seas Seafood saw earnings per share decrease by 60% last year. And it has shrunk its earnings per share by 38% per year over the last five years. This growth rate might warrant a below average P/E ratio.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. That means it doesn't take debt or cash into account. 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.

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.

How Does Clean Seas Seafood's Debt Impact Its P/E Ratio?

Net debt totals 10% of Clean Seas Seafood's market cap. It would probably deserve a higher P/E ratio if it was net cash, since it would have more options for growth.

The Verdict On Clean Seas Seafood's P/E Ratio

Clean Seas Seafood trades on a P/E ratio of 40.9, which is above its market average of 18.7. With some debt but no EPS growth last year, the market has high expectations of future profits.

When the market is wrong about a stock, it gives savvy investors an opportunity. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. Although we don't have analyst forecasts you might want to assess this data-rich visualization of earnings, revenue and cash flow.

But note: Clean Seas Seafood 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).

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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.