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Should We Worry About Canadian Tire Corporation, Limited's (TSE:CTC.A) P/E Ratio?

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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 Canadian Tire Corporation, Limited's (TSE:CTC.A) P/E ratio to inform your assessment of the investment opportunity. Canadian Tire has a P/E ratio of 13.34, based on the last twelve months. That corresponds to an earnings yield of approximately 7.5%.

Check out our latest analysis for Canadian Tire

How Do I Calculate A Price To Earnings Ratio?

The formula for P/E is:

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

Or for Canadian Tire:

P/E of 13.34 = CA$142.68 ÷ CA$10.7 (Based on the trailing twelve months to March 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each CA$1 of company earnings. 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

Earnings growth rates have a big influence on P/E ratios. Earnings growth means that in the future the 'E' will be higher. That means unless the share price increases, the P/E will reduce in a few years. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Canadian Tire had pretty flat EPS growth in the last year. But EPS is up 9.0% over the last 5 years.

Does Canadian Tire Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio essentially measures market expectations of a company. The image below shows that Canadian Tire has a higher P/E than the average (10.1) P/E for companies in the multiline retail industry.

TSX:CTC.A Price Estimation Relative to Market, July 2nd 2019

Canadian Tire'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 investors should delve deeper. I like to check if company insiders have been buying or selling.

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

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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.

So What Does Canadian Tire's Balance Sheet Tell Us?

Canadian Tire has net debt worth 83% 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 Canadian Tire's P/E Ratio

Canadian Tire's P/E is 13.3 which is below average (14.9) in the CA market. Given meaningful debt, and a lack of recent growth, the market looks to be extrapolating this recent performance; reflecting low expectations for the future.

Investors have an opportunity when market expectations about a stock are wrong. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

But note: Canadian Tire 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.