Is Wm Morrison Supermarkets PLC’s (LON:MRW) High P/E Ratio A Problem For Investors?

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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll look at Wm Morrison Supermarkets PLC’s (LON:MRW) P/E ratio and reflect on what it tells us about the company’s share price. What is Wm Morrison Supermarkets’s P/E ratio? Well, based on the last twelve months it is 19.23. In other words, at today’s prices, investors are paying £19.23 for every £1 in prior year profit.

See our latest analysis for Wm Morrison Supermarkets

How Do I Calculate A Price To Earnings Ratio?

The formula for price to earnings is:

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

Or for Wm Morrison Supermarkets:

P/E of 19.23 = £1.99 ÷ £0.10 (Based on the trailing twelve months to February 2019.)

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 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 Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. 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. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

Wm Morrison Supermarkets’s earnings per share fell by 22% in the last twelve months. But EPS is up 2.8% over the last 3 years.

Does Wm Morrison Supermarkets 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. As you can see below Wm Morrison Supermarkets has a P/E ratio that is fairly close for the average for the consumer retailing industry, which is 18.5.

LSE:MRW Price Estimation Relative to Market, June 20th 2019
LSE:MRW Price Estimation Relative to Market, June 20th 2019

Wm Morrison Supermarkets’s P/E tells us that market participants think its prospects are roughly in line with its industry. The company could surprise by performing better than average, in the future. I inform my view byby checking management tenure and remuneration, among other things.

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. In other words, it does not consider any debt or cash that the company may have on the balance sheet. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.

While growth expenditure doesn’t always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.

Is Debt Impacting Wm Morrison Supermarkets’s P/E?

Wm Morrison Supermarkets’s net debt is 22% of its market cap. 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 Wm Morrison Supermarkets’s P/E Ratio

Wm Morrison Supermarkets has a P/E of 19.2. That’s higher than the average in the GB market, which is 16.2. With modest debt but no EPS growth in the last year, it’s fair to say the P/E implies some optimism about future earnings, from the market.

Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

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

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 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. Thank you for reading.