Here's How P/E Ratios Can Help Us Understand A.G. BARR p.l.c. (LON:BAG)

The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we'll show how A.G. BARR p.l.c.'s (LON:BAG) P/E ratio could help you assess the value on offer. A.G. BARR has a P/E ratio of 18.23, based on the last twelve months. In other words, at today's prices, investors are paying £18.23 for every £1 in prior year profit.

View our latest analysis for A.G. BARR

How Do I Calculate A Price To Earnings Ratio?

The formula for P/E is:

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

Or for A.G. BARR:

P/E of 18.23 = £4.830 ÷ £0.265 (Based on the trailing twelve months to January 2020.)

(Note: the above calculation results may not be precise due to rounding.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each £1 of company earnings. That isn't necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.

How Does A.G. BARR's P/E Ratio Compare To Its Peers?

One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. We can see in the image below that the average P/E (22.6) for companies in the beverage industry is higher than A.G. BARR's P/E.

Its relatively low P/E ratio indicates that A.G. BARR shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. You should delve deeper. I like to check if company insiders have been buying or selling.

How Growth Rates Impact P/E Ratios

Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. That means unless the share price falls, the P/E will increase in a few years. Then, a higher P/E might scare off shareholders, pushing the share price down.

A.G. BARR's earnings per share fell by 16% in the last twelve months. And over the longer term (3 years) earnings per share have decreased 4.9% annually. This could justify a low P/E.

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

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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 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.

Is Debt Impacting A.G. BARR's P/E?

Since A.G. BARR holds net cash of UK£11m, it can spend on growth, justifying a higher P/E ratio than otherwise.

The Bottom Line On A.G. BARR's P/E Ratio

A.G. BARR has a P/E of 18.2. That's higher than the average in its market, which is 15.0. Falling earnings per share is probably keeping traditional value investors away, but the net cash position means the company has time to improve: and the high P/E suggests the market thinks it will.

Investors should be looking to buy stocks that the market is wrong about. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

But note: A.G. BARR may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

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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. 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. Simply Wall St has no position in any stocks mentioned. Thank you for reading.