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Why The J. M. Smucker Company's (NYSE:SJM) High P/E Ratio Isn't Necessarily A Bad Thing

Simply Wall St

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This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll show how you can use The J. M. Smucker Company's (NYSE:SJM) P/E ratio to inform your assessment of the investment opportunity. J. M. Smucker has a P/E ratio of 20.97, based on the last twelve months. That corresponds to an earnings yield of approximately 4.8%.

Check out our latest analysis for J. M. Smucker

How Do You Calculate J. M. Smucker's P/E Ratio?

The formula for P/E is:

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

Or for J. M. Smucker:

P/E of 20.97 = $115.93 ÷ $5.53 (Based on the trailing twelve months to January 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. That isn't a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.

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. When earnings grow, the 'E' increases, over time. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.

J. M. Smucker's earnings per share fell by 50% in the last twelve months. But over the longer term (5 years) earnings per share have increased by 18%.

How Does J. M. Smucker's P/E Ratio Compare To Its Peers?

The P/E ratio indicates whether the market has higher or lower expectations of a company. You can see in the image below that the average P/E (20) for companies in the food industry is roughly the same as J. M. Smucker's P/E.

NYSE:SJM Price Estimation Relative to Market, March 26th 2019

J. M. Smucker's P/E tells us that market participants think its prospects are roughly in line with its industry. So if J. M. Smucker actually outperforms its peers going forward, that should be a positive for the share price. Checking factors such as the tenure of the board and management could help you form your own view on if that will happen.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

Don't forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. Theoretically, a business can improve its earnings (and produce a lower P/E in the future), by taking on debt (or spending its remaining cash).

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.

Is Debt Impacting J. M. Smucker's P/E?

J. M. Smucker has net debt worth 45% of its market capitalization. If you want to compare its P/E ratio to other companies, you should absolutely keep in mind it has significant borrowings.

The Bottom Line On J. M. Smucker's P/E Ratio

J. M. Smucker's P/E is 21 which is above average (17.2) in the US market. With some debt but no EPS growth last year, the market has high expectations of future profits.

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

Of course you might be able to find a better stock than J. M. Smucker. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.