Today, we’ll introduce the concept of the P/E ratio for those who are learning about investing. To keep it practical, we’ll show how BJ’s Wholesale Club Holdings, Inc.’s (NYSE:BJ) P/E ratio could help you assess the value on offer. BJ’s Wholesale Club Holdings has a P/E ratio of 25.97, based on the last twelve months. That is equivalent to an earnings yield of about 3.9%.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for BJ’s Wholesale Club Holdings:
P/E of 25.97 = $28.31 ÷ $1.09 (Based on the year 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. 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
Probably the most important factor in determining what P/E a company trades on is the earnings growth. Earnings growth means that in the future the ‘E’ will be higher. And in that case, the P/E ratio itself will drop rather quickly. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
BJ’s Wholesale Club Holdings’s earnings made like a rocket, taking off 85% last year. The cherry on top is that the five year growth rate was an impressive 31% per year. So I’d be surprised if the P/E ratio was not above average.
Does BJ’s Wholesale Club Holdings Have A Relatively High Or Low P/E For Its Industry?
We can get an indication of market expectations by looking at the P/E ratio. You can see in the image below that the average P/E (21) for companies in the consumer retailing industry is lower than BJ’s Wholesale Club Holdings’s P/E.
BJ’s Wholesale Club Holdings’s P/E tells us that market participants think the company will perform better than its industry peers, going forward. Shareholders are clearly optimistic, but the future is always uncertain. So investors should delve deeper. I like to check if company insiders have been buying or selling.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The ‘Price’ in P/E reflects the market capitalization of the company. 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.
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.
BJ’s Wholesale Club Holdings’s Balance Sheet
BJ’s Wholesale Club Holdings’s net debt equates to 47% of its market capitalization. While it’s worth keeping this in mind, it isn’t a worry.
The Verdict On BJ’s Wholesale Club Holdings’s P/E Ratio
BJ’s Wholesale Club Holdings has a P/E of 26. That’s higher than the average in the US market, which is 18.1. Its debt levels do not imperil its balance sheet and its EPS growth is very healthy indeed. So to be frank we are not surprised it has a high P/E ratio.
Investors have an opportunity when market expectations about a stock are wrong. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
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 firstname.lastname@example.org. 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.