To the annoyance of some shareholders, Treasury Wine Estates (ASX:TWE) shares are down a considerable 31% in the last month. The recent drop has obliterated the annual return, with the share price now down 29% over that longer period.
Assuming nothing else has changed, a lower share price makes a stock more attractive to potential buyers. In the long term, share prices tend to follow earnings per share, but in the short term prices bounce around in response to short term factors (which are not always obvious). So, on certain occasions, long term focussed investors try to take advantage of pessimistic expectations to buy shares at a better price. One way to gauge market expectations of a stock is to look at its Price to Earnings Ratio (PE Ratio). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.
Does Treasury Wine Estates Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 20.56 that sentiment around Treasury Wine Estates isn't particularly high. If you look at the image below, you can see Treasury Wine Estates has a lower P/E than the average (22.6) in the beverage industry classification.
This suggests that market participants think Treasury Wine Estates will underperform other companies in its industry. Since the market seems unimpressed with Treasury Wine Estates, 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. And in that case, the P/E ratio itself will drop rather quickly. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
Treasury Wine Estates increased earnings per share by 5.0% last year. And it has improved its earnings per share by 19% per year over the last three years.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
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. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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 Treasury Wine Estates's P/E?
Treasury Wine Estates's net debt is 9.5% 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 Verdict On Treasury Wine Estates's P/E Ratio
Treasury Wine Estates trades on a P/E ratio of 20.6, which is above its market average of 18.8. With debt at prudent levels and improving earnings, it's fair to say the market expects steady progress in the future. Given Treasury Wine Estates's P/E ratio has declined from 29.6 to 20.6 in the last month, we know for sure that the market is significantly less confident about the business today, than it was back then. For those who prefer to invest with the flow of momentum, that might be a bad sign, but for a contrarian, it may signal opportunity.
Investors have an opportunity when market expectations about a stock are wrong. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. 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: Treasury Wine Estates 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 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.
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