The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll show how you can use Canadian Pacific Railway Limited’s (TSE:CP) P/E ratio to inform your assessment of the investment opportunity. Canadian Pacific Railway has a P/E ratio of 16.57, based on the last twelve months. That means that at current prices, buyers pay CA$16.57 for every CA$1 in trailing yearly profits.
How Do I Calculate Canadian Pacific Railway’s Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Canadian Pacific Railway:
P/E of 16.57 = CA$275.65 ÷ CA$16.64 (Based on the trailing twelve months to September 2018.)
Is A High P/E 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. 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
Probably the most important factor in determining what P/E a company trades on is the earnings growth. When earnings grow, the ‘E’ increases, over time. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.
It’s nice to see that Canadian Pacific Railway grew EPS by a stonking 35% in the last year. And it has bolstered its earnings per share by 23% per year over the last five years. So we’d generally expect it to have a relatively high P/E ratio.
How Does Canadian Pacific Railway’s P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. You can see in the image below that the average P/E (10.4) for companies in the transportation industry is lower than Canadian Pacific Railway’s P/E.
Its relatively high P/E ratio indicates that Canadian Pacific Railway shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. 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
The ‘Price’ in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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.
Canadian Pacific Railway’s Balance Sheet
Canadian Pacific Railway has net debt worth 21% of its market capitalization. It would probably deserve a higher P/E ratio if it was net cash, since it would have more options for growth.
The Verdict On Canadian Pacific Railway’s P/E Ratio
Canadian Pacific Railway’s P/E is 16.6 which is above average (14.4) in the CA market. The company is not overly constrained by its modest debt levels, and it is growing earnings per share. So it does not seem strange that the P/E is above average.
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 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 Canadian Pacific Railway. 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).
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 email@example.com.