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 Sleep Country Canada Holdings Inc.’s (TSE:ZZZ) P/E ratio could help you assess the value on offer. Sleep Country Canada Holdings has a price to earnings ratio of 11.38, based on the last twelve months. In other words, at today’s prices, investors are paying CA$11.38 for every CA$1 in prior year profit.
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 Sleep Country Canada Holdings:
P/E of 11.38 = CA$17.54 ÷ CA$1.54 (Based on the year to March 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 CA$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.
Does Sleep Country Canada Holdings Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. You can see in the image below that the average P/E (11.3) for companies in the specialty retail industry is roughly the same as Sleep Country Canada Holdings’s P/E.
That indicates that the market expects Sleep Country Canada Holdings will perform roughly in line with other companies in its industry.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. That means even if the current P/E is high, it will reduce over time if the share price stays flat. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Sleep Country Canada Holdings saw earnings per share decrease by 2.6% last year. But it has grown its earnings per share by 129% per year over the last five years.
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. That means it doesn’t take debt or cash into account. 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 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 Sleep Country Canada Holdings’s Balance Sheet Tell Us?
Sleep Country Canada Holdings has net debt worth 25% of its market capitalization. That’s enough debt to impact the P/E ratio a little; so keep it in mind if you’re comparing it to companies without debt.
The Verdict On Sleep Country Canada Holdings’s P/E Ratio
Sleep Country Canada Holdings’s P/E is 11.4 which is below average (14.3) in the CA market. With only modest debt, it’s likely the lack of EPS growth at least partially explains the pessimism implied by the P/E ratio.
When the market is wrong about a stock, it gives savvy investors an opportunity. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
You might be able to find a better buy than Sleep Country Canada Holdings. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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 email@example.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.