The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll look at Jack in the Box Inc.’s (NASDAQ:JACK) P/E ratio and reflect on what it tells us about the company’s share price. Looking at earnings over the last twelve months, Jack in the Box has a P/E ratio of 17.89. That is equivalent to an earnings yield of about 5.6%.
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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 Jack in the Box:
P/E of 17.89 = $81.95 ÷ $4.58 (Based on the year to April 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
Generally speaking the rate of earnings growth has a profound impact on a company’s P/E multiple. When earnings grow, the ‘E’ increases, over time. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
Jack in the Box increased earnings per share by a whopping 34% last year. And its annual EPS growth rate over 5 years is 16%. So we’d generally expect it to have a relatively high P/E ratio.
Does Jack in the Box Have A Relatively High Or Low P/E For Its Industry?
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 (23.1) for companies in the hospitality industry is higher than Jack in the Box’s P/E.
This suggests that market participants think Jack in the Box will underperform other companies in its industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
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. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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.
Jack in the Box’s Balance Sheet
Net debt is 50% of Jack in the Box’s market cap. You’d want to be aware of this fact, but it doesn’t bother us.
The Verdict On Jack in the Box’s P/E Ratio
Jack in the Box trades on a P/E ratio of 17.9, which is fairly close to the US market average of 17.8. When you consider the impressive EPS growth last year (along with some debt), it seems the market has questions about whether rapid EPS growth will be sustained.
When the market is wrong about a stock, it gives savvy investors an opportunity. As value investor Benjamin Graham famously said, ‘In the short run, the market is a voting machine but in the long run, it is a weighing machine.’ 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 be able to find a better stock than Jack in the Box. 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 email@example.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.