U.S. Markets closed

Is Treasury Wine Estates Limited’s (ASX:TWE) High P/E Ratio A Problem For Investors?

Want to participate in a short research study? Help shape the future of investing tools and you could win a \$250 gift card!

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 Treasury Wine Estates Limited’s (ASX:TWE) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Treasury Wine Estates’s P/E ratio is 31.82. That corresponds to an earnings yield of approximately 3.1%.

How Do You Calculate Treasury Wine Estates’s P/E Ratio?

The formula for P/E is:

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

Or for Treasury Wine Estates:

P/E of 31.82 = A\$15.8 ÷ A\$0.50 (Based on the trailing twelve months to June 2018.)

Is A High P/E Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each A\$1 of company earnings. All else being equal, it’s better to pay a low price — but as Warren Buffett said, ‘It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.’

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. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.

Notably, Treasury Wine Estates grew EPS by a whopping 36% in the last year. And its annual EPS growth rate over 5 years is 48%. I’d therefore be a little surprised if its P/E ratio was not relatively high.

How Does Treasury Wine Estates’s P/E Ratio Compare To Its Peers?

The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that Treasury Wine Estates has a higher P/E than the average (26) P/E for companies in the beverage industry.

Its relatively high P/E ratio indicates that Treasury Wine Estates shareholders think it will perform better than other companies in its industry classification. The market is optimistic about the future, but that doesn’t guarantee future growth. So further research is always essential. I often monitor director buying and selling.

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. 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 spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.

Treasury Wine Estates’s Balance Sheet

Treasury Wine Estates’s net debt is 7.0% of its market cap. The market might award it a higher P/E ratio if it had net cash, but its unlikely this low level of net borrowing is having a big impact on the P/E multiple.

The Bottom Line On Treasury Wine Estates’s P/E Ratio

Treasury Wine Estates’s P/E is 31.8 which is above average (15.3) in the AU market. Its debt levels do not imperil its balance sheet and it has already proven it can grow. So it is not surprising the market is probably extrapolating recent growth well into the future, reflected in the relatively high P/E ratio.

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 report on the analyst consensus forecasts could help you make a master move on this stock.

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.

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 editorial-team@simplywallst.com.