The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll look at Campbell Soup Company's (NYSE:CPB) P/E ratio and reflect on what it tells us about the company's share price. Campbell Soup has a price to earnings ratio of 30.51, based on the last twelve months. In other words, at today's prices, investors are paying $30.51 for every $1 in prior year profit.
How Do I Calculate Campbell Soup's Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Campbell Soup:
P/E of 30.51 = $48.04 ÷ $1.57 (Based on the year to July 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each $1 the company has earned over the last year. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
How Does Campbell Soup's P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. You can see in the image below that the average P/E (24.7) for companies in the food industry is lower than Campbell Soup's P/E.
Campbell Soup's P/E tells us that market participants think the company will perform better than its industry peers, going forward. 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
If earnings fall then in the future the 'E' will be lower. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. Then, a higher P/E might scare off shareholders, pushing the share price down.
Campbell Soup saw earnings per share decrease by 35% last year. And over the longer term (5 years) earnings per share have decreased 8.8% annually. This growth rate might warrant a below average P/E ratio.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. 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.
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).
How Does Campbell Soup's Debt Impact Its P/E Ratio?
Net debt totals 58% of Campbell Soup's market cap. This is enough debt that you'd have to make some adjustments before using the P/E ratio to compare it to a company with net cash.
The Verdict On Campbell Soup's P/E Ratio
Campbell Soup trades on a P/E ratio of 30.5, which is above its market average of 18.2. With meaningful debt and a lack of recent earnings growth, the market has high expectations that the business will earn more in the future.
Investors have an opportunity when market expectations about a stock are wrong. 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 visual report on analyst forecasts could hold the key to an excellent investment decision.
But note: Campbell Soup 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).
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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. Thank you for reading.