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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 Williams-Sonoma, Inc.’s (NYSE:WSM) P/E ratio could help you assess the value on offer. Williams-Sonoma has a P/E ratio of 15.23, based on the last twelve months. That corresponds to an earnings yield of approximately 6.6%.
Check out our latest analysis for Williams-Sonoma
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 Williams-Sonoma:
P/E of 15.23 = $50.56 ÷ $3.32 (Based on the trailing twelve months to October 2018.)
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 necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
How Growth Rates Impact P/E Ratios
When earnings fall, the ‘E’ decreases, over time. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
Williams-Sonoma saw earnings per share decrease by 6.9% last year. But EPS is up 2.0% over the last 5 years. And EPS is down 2.4% a year, over the last 3 years. So it would be surprising to see a high P/E.
How Does Williams-Sonoma’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. The image below shows that Williams-Sonoma has a P/E ratio that is roughly in line with the specialty retail industry average (14.2).
That indicates that the market expects Williams-Sonoma will perform roughly in line with other companies in its industry. If the company has better than average prospects, then the market might be underestimating it. Further research into factors such asmanagement tenure, could help you form your own view on whether that is likely.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
The ‘Price’ in P/E reflects the market capitalization of the company. That means it doesn’t take debt or cash into account. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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.
Williams-Sonoma’s Balance Sheet
Williams-Sonoma has net debt worth just 4.9% of its market capitalization. It would probably trade on a higher P/E ratio if it had a lot of cash, but I doubt it is having a big impact.