Does Redrow plc (LON:RDW) Have A Good P/E Ratio?

This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to Redrow plc's (LON:RDW), to help you decide if the stock is worth further research. What is Redrow's P/E ratio? Well, based on the last twelve months it is 8.52. In other words, at today's prices, investors are paying £8.52 for every £1 in prior year profit.

See our latest analysis for Redrow

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 Redrow:

P/E of 8.52 = GBP7.87 ÷ GBP0.92 (Based on the trailing twelve months to June 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each GBP1 of company earnings. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.

Does Redrow Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that Redrow has a lower P/E than the average (12.5) P/E for companies in the consumer durables industry.

Redrow's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Redrow, it's quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.

How Growth Rates Impact P/E Ratios

Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. Earnings growth means that in the future the 'E' will be higher. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

Redrow's earnings per share grew by -3.2% in the last twelve months. And earnings per share have improved by 25% annually, over the last five years.

Remember: P/E Ratios Don't Consider The Balance Sheet

The 'Price' in P/E reflects the market capitalization of the company. So it won't reflect the advantage of cash, or disadvantage of debt. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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 Redrow's Balance Sheet Tell Us?

Since Redrow holds net cash of UK£124m, it can spend on growth, justifying a higher P/E ratio than otherwise.

The Bottom Line On Redrow's P/E Ratio

Redrow trades on a P/E ratio of 8.5, which is below the GB market average of 18.4. EPS was up modestly better over the last twelve months. And the net cash position gives the company many options. So it's strange that the low P/E indicates low expectations.

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 visual report on analyst forecasts could hold the key to an excellent investment decision.

Of course you might be able to find a better stock than Redrow. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.