Why Wawel S.A.’s (WSE:WWL) High P/E Ratio Isn’t Necessarily A Bad Thing

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Today, we’ll introduce the concept of the P/E ratio for those who are learning about investing. We’ll show how you can use Wawel S.A.’s (WSE:WWL) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Wawel’s P/E ratio is 13. In other words, at today’s prices, investors are paying PLN13 for every PLN1 in prior year profit.

See our latest analysis for Wawel

How Do You Calculate A P/E Ratio?

The formula for P/E is:

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

Or for Wawel:

P/E of 13 = PLN592 ÷ PLN45.53 (Based on the year to March 2019.)

Is A High P/E Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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

If earnings fall then in the future the ‘E’ will be lower. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. Then, a higher P/E might scare off shareholders, pushing the share price down.

Wawel shrunk earnings per share by 40% over the last year. And over the longer term (5 years) earnings per share have decreased 3.3% annually. This could justify a pessimistic P/E.

Does Wawel 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, Wawel has a higher P/E than the average company (7.5) in the food industry.

WSE:WWL Price Estimation Relative to Market, June 24th 2019
WSE:WWL Price Estimation Relative to Market, June 24th 2019

Wawel’s P/E tells us that market participants think the company will perform better than its industry peers, going forward. The market is optimistic about the future, but that doesn’t guarantee future growth. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

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. 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.

How Does Wawel’s Debt Impact Its P/E Ratio?

Wawel has net cash of zł171m. This is fairly high at 19% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.

The Verdict On Wawel’s P/E Ratio

Wawel has a P/E of 13. That’s higher than the average in the PL market, which is 10.9. 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. 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 Wawel. 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.