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Why Recipe Unlimited Corporation's (TSE:RECP) High P/E Ratio Isn't Necessarily A Bad Thing

Simply Wall St

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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll look at Recipe Unlimited Corporation's (TSE:RECP) P/E ratio and reflect on what it tells us about the company's share price. Recipe Unlimited has a price to earnings ratio of 21.85, based on the last twelve months. That is equivalent to an earnings yield of about 4.6%.

Check out our latest analysis for Recipe Unlimited

How Do You Calculate A P/E Ratio?

The formula for price to earnings is:

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

Or for Recipe Unlimited:

P/E of 21.85 = CA$26.25 ÷ CA$1.2 (Based on the trailing twelve months to March 2019.)

Is A High P/E Ratio Good?

A higher P/E ratio means that buyers have to pay a higher price for each CA$1 the company has earned over the last year. 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 Recipe Unlimited's P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. As you can see below, Recipe Unlimited has a higher P/E than the average company (17.2) in the hospitality industry.

TSX:RECP Price Estimation Relative to Market, July 18th 2019

Its relatively high P/E ratio indicates that Recipe Unlimited shareholders think it will perform better than other companies in its industry classification. 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. 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.

Recipe Unlimited's earnings per share fell by 18% in the last twelve months. And over the longer term (3 years) earnings per share have decreased 19% annually. This growth rate might warrant a low P/E ratio.

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. 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.

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.

How Does Recipe Unlimited's Debt Impact Its P/E Ratio?

Net debt is 25% of Recipe Unlimited's market cap. You'd want to be aware of this fact, but it doesn't bother us.

The Bottom Line On Recipe Unlimited's P/E Ratio

Recipe Unlimited trades on a P/E ratio of 21.9, which is above its market average of 15. With some debt but no EPS growth last year, the market has high expectations of future profits.

When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. 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.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E 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.