This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we’ll show how The Food Revolution Group Limited’s (ASX:FOD) P/E ratio could help you assess the value on offer. Based on the last twelve months, Food Revolution Group’s P/E ratio is 32.24. That means that at current prices, buyers pay A$32.24 for every A$1 in trailing yearly profits.
Check out our latest analysis for Food Revolution Group
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Food Revolution Group:
P/E of 32.24 = A$0.17 ÷ A$0.0051 (Based on the year to June 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each A$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 Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. When earnings grow, the ‘E’ increases, over time. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.
Food Revolution Group increased earnings per share by an impressive 19% over the last twelve months. And its annual EPS growth rate over 5 years is 89%. This could arguably justify a relatively high P/E ratio.
How Does Food Revolution Group’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that Food Revolution Group has a higher P/E than the average (20.4) P/E for companies in the food industry.
That means that the market expects Food Revolution Group will outperform other companies in its industry. Clearly the market expects growth, but it isn’t guaranteed. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don’t forget that the P/E ratio considers market capitalization. In other words, it does not consider any debt or cash that the company may have on the balance sheet. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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.