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Is UniFirst Corporation's (NYSE:UNF) P/E Ratio Really That Good?

Simply Wall St

Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at UniFirst Corporation's (NYSE:UNF) P/E ratio and reflect on what it tells us about the company's share price. UniFirst has a price to earnings ratio of 21.93, based on the last twelve months. That means that at current prices, buyers pay $21.93 for every $1 in trailing yearly profits.

See our latest analysis for UniFirst

How Do You Calculate A P/E Ratio?

The formula for price to earnings is:

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

Or for UniFirst:

P/E of 21.93 = $192.88 ÷ $8.79 (Based on the trailing twelve months to May 2019.)

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. 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 Does UniFirst's P/E Ratio Compare To Its Peers?

The P/E ratio indicates whether the market has higher or lower expectations of a company. We can see in the image below that the average P/E (24.4) for companies in the commercial services industry is higher than UniFirst's P/E.

NYSE:UNF Price Estimation Relative to Market, September 17th 2019

Its relatively low P/E ratio indicates that UniFirst shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with UniFirst, 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

Earnings growth rates have a big influence on P/E ratios. 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. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

UniFirst increased earnings per share by a whopping 42% last year. And earnings per share have improved by 7.7% annually, over the last five years. I'd therefore be a little surprised if its P/E ratio was not relatively high.

Remember: P/E Ratios Don't Consider The Balance Sheet

The 'Price' in P/E reflects the market capitalization of the company. So it won't reflect the advantage of cash, or disadvantage of debt. 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.

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.

So What Does UniFirst's Balance Sheet Tell Us?

The extra options and safety that comes with UniFirst's US$349m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.

The Bottom Line On UniFirst's P/E Ratio

UniFirst has a P/E of 21.9. That's higher than the average in its market, which is 18.2. The excess cash it carries is the gravy on top its fast EPS growth. To us, this is the sort of company that we would expect to carry an above average price tag (relative to earnings).

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. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

But note: UniFirst 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 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. Thank you for reading.