Why ForFarmers N.V.'s (AMS:FFARM) High P/E Ratio Isn't Necessarily A Bad Thing

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 ForFarmers N.V.'s (AMS:FFARM) P/E ratio could help you assess the value on offer. ForFarmers has a P/E ratio of 17.31, based on the last twelve months. That is equivalent to an earnings yield of about 5.8%.

View our latest analysis for ForFarmers

How Do You Calculate A P/E Ratio?

The formula for P/E is:

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

Or for ForFarmers:

P/E of 17.31 = €5.65 ÷ €0.33 (Based on the trailing twelve months to June 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 necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.

Does ForFarmers 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 (17.0) for companies in the food industry is roughly the same as ForFarmers's P/E.

Its P/E ratio suggests that ForFarmers shareholders think that in the future it will perform about the same as other companies in its industry classification. So if ForFarmers actually outperforms its peers going forward, that should be a positive for the share price. Checking factors such as director buying and selling. could help you form your own view on if that will happen.

How Growth Rates Impact P/E Ratios

When earnings fall, the 'E' decreases, over time. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.

ForFarmers shrunk earnings per share by 47% over the last year. And EPS is down 12% a year, over the last 3 years. This could justify a low P/E.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

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.

How Does ForFarmers's Debt Impact Its P/E Ratio?

ForFarmers has net debt worth 11% of its market capitalization. This could bring some additional risk, and reduce the number of investment options for management; worth remembering if you compare its P/E to businesses without debt.

The Verdict On ForFarmers's P/E Ratio

ForFarmers trades on a P/E ratio of 17.3, which is below the NL market average of 19.1. With only modest debt, it's likely the lack of EPS growth at least partially explains the pessimism implied by the P/E ratio.

Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. 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 ForFarmers. 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.