Should You Be Tempted To Sell Stella-Jones Inc. (TSE:SJ) Because Of Its 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). To keep it practical, we'll show how Stella-Jones Inc.'s (TSE:SJ) P/E ratio could help you assess the value on offer. Based on the last twelve months, Stella-Jones's P/E ratio is 17.42. That is equivalent to an earnings yield of about 5.7%.

Check out our latest analysis for Stella-Jones

How Do I Calculate A Price To Earnings Ratio?

The formula for price to earnings is:

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

Or for Stella-Jones:

P/E of 17.42 = CA$42.23 ÷ CA$2.42 (Based on the trailing twelve months to September 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 is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. 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.

Most would be impressed by Stella-Jones earnings growth of 24% in the last year. And it has bolstered its earnings per share by 12% per year over the last five years. So one might expect an above average P/E ratio.

How Does Stella-Jones's P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. You can see in the image below that the average P/E (7.3) for companies in the forestry industry is lower than Stella-Jones's P/E.

That means that the market expects Stella-Jones will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. So further research is always essential. I often monitor director buying and selling.

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. Thus, the metric does not reflect cash or debt held by the company. Theoretically, a business can improve its earnings (and produce a lower P/E in the future), by taking on debt (or spending its remaining cash).

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.

How Does Stella-Jones's Debt Impact Its P/E Ratio?

Stella-Jones has net debt worth 17% of its market capitalization. This could bring some additional risk, and reduce the number of investment options for management; worth remembering if you compare its P/E to businesses without debt.

The Verdict On Stella-Jones's P/E Ratio

Stella-Jones trades on a P/E ratio of 17.4, which is above the CA market average of 14.5. While the company does use modest debt, its recent earnings growth is impressive. Therefore it seems reasonable that the market would have relatively high expectations of the company

When the market is wrong about a stock, it gives savvy investors an opportunity. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine.' So this freevisual report on analyst forecasts could hold they key to an excellent investment decision.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this freelist of companies with modest (or no) debt, trading on a P/E below 20.

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.

Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.