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Do You Like Waterloo Brewing Ltd. (TSE:WBR) At This P/E Ratio?

Simply Wall St

Of late the Waterloo Brewing (TSE:WBR) share price has softened like an ice cream in the sun, melting a full . But there's still good reason for shareholders to be content; the stock has gained 15% in the last 90 days. Looking back further, the stock is up 8.5% in the last year.

All else being equal, a sharp share price increase should make a stock less attractive to potential investors. 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 some would prefer to hold off buying when there is a lot of optimism towards a stock. One way to gauge market expectations of a stock is to look at its Price to Earnings Ratio (PE Ratio). A high P/E implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.

Check out our latest analysis for Waterloo Brewing

How Does Waterloo Brewing's P/E Ratio Compare To Its Peers?

We can tell from its P/E ratio of 62.05 that there is some investor optimism about Waterloo Brewing. As you can see below, Waterloo Brewing has a higher P/E than the average company (29.6) in the beverage industry.

TSX:WBR Price Estimation Relative to Market, January 11th 2020

That means that the market expects Waterloo Brewing will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should delve deeper. I like to check if company insiders have been buying or selling.

How Growth Rates Impact P/E Ratios

Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. That means unless the share price falls, the P/E will increase in a few years. Then, a higher P/E might scare off shareholders, pushing the share price down.

Waterloo Brewing's 133% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. Regrettably, the longer term performance is poor, with EPS down -14% per year over 3 years.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. Thus, the metric does not reflect cash or debt held by the company. 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.

Waterloo Brewing's Balance Sheet

Net debt totals just 6.6% of Waterloo Brewing's market cap. It would probably trade on a higher P/E ratio if it had a lot of cash, but I doubt it is having a big impact.

The Verdict On Waterloo Brewing's P/E Ratio

Waterloo Brewing's P/E is 62.0 which suggests the market is more focussed on the future opportunity rather than the current level of earnings. Its debt levels do not imperil its balance sheet and its EPS growth is very healthy indeed. So to be frank we are not surprised it has a high P/E ratio. What can be absolutely certain is that the market has become less optimistic about Waterloo Brewing over the last month, with the P/E ratio falling from 62.0 back then to 62.0 today. 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.

You might be able to find a better buy than Waterloo Brewing. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

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.