The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We’ll show how you can use National Beverage Corp.’s (NASDAQ:FIZZ) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, National Beverage’s P/E ratio is 17.81. That is equivalent to an earnings yield of about 5.6%.
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for National Beverage:
P/E of 17.81 = $57.73 ÷ $3.24 (Based on the trailing twelve months to January 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each $1 the company has earned over the last year. 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 Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. When earnings grow, the ‘E’ increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
National Beverage saw earnings per share improve by -6.1% last year. And it has bolstered its earnings per share by 31% per year over the last five years.
How Does National Beverage’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. We can see in the image below that the average P/E (27.2) for companies in the beverage industry is higher than National Beverage’s P/E.
Its relatively low P/E ratio indicates that National Beverage 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. 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
Don’t forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. Theoretically, a business can improve its earnings (and produce a lower P/E in the future), by taking on debt (or spending its remaining cash).
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
National Beverage’s Balance Sheet
Since National Beverage holds net cash of US$270m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Bottom Line On National Beverage’s P/E Ratio
National Beverage has a P/E of 17.8. That’s around the same as the average in the US market, which is 17.7. Recent earnings growth wasn’t bad. And the net cash position gives the company many options. The average P/E suggests the market isn’t overly optimistic, though.
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 visual report on analyst forecasts could hold the key to an excellent investment decision.
But note: National Beverage 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).
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.