Despite Its High P/E Ratio, Is A.P. Eagers Limited (ASX:APE) Still Undervalued?

This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll look at A.P. Eagers Limited's (ASX:APE) P/E ratio and reflect on what it tells us about the company's share price. Looking at earnings over the last twelve months, A.P. Eagers has a P/E ratio of 19.98. That corresponds to an earnings yield of approximately 5.0%.

View our latest analysis for A.P. Eagers

How Do You Calculate A P/E Ratio?

The formula for P/E is:

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

Or for A.P. Eagers:

P/E of 19.98 = A$9.50 ÷ A$0.48 (Based on the year to June 2019.)

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. 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 Does A.P. Eagers'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 (16.7) for companies in the specialty retail industry is lower than A.P. Eagers's P/E.

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

How Growth Rates Impact P/E Ratios

Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. Then, a higher P/E might scare off shareholders, pushing the share price down.

A.P. Eagers saw earnings per share decrease by 7.3% last year. But over the longer term (5 years) earnings per share have increased by 5.2%. And it has shrunk its earnings per share by 1.2% per year over the last three years. This growth rate might warrant a low P/E ratio. So you wouldn't expect a very high P/E. The market might therefore be optimistic about the future, but that doesn't guarantee future growth. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. So it won't reflect the advantage of cash, or disadvantage of debt. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its 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.

A.P. Eagers's Balance Sheet

A.P. Eagers has net debt equal to 35% of its market cap. You'd want to be aware of this fact, but it doesn't bother us.

The Verdict On A.P. Eagers's P/E Ratio

A.P. Eagers trades on a P/E ratio of 20.0, which is fairly close to the AU market average of 18.6. When you consider the lack of EPS growth last year (along with some debt), it seems the market is optimistic about the future for the business.

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 visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.

But note: A.P. Eagers 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).

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.

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. Thank you for reading.