This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We’ll show how you can use Lancaster Colony Corporation’s (NASDAQ:LANC) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Lancaster Colony’s P/E ratio is 28.96. That corresponds to an earnings yield of approximately 3.5%.
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 Lancaster Colony:
P/E of 28.96 = $154.87 ÷ $5.35 (Based on the year to December 2018.)
Is A High P/E Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each $1 of company earnings. 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. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.
Most would be impressed by Lancaster Colony earnings growth of 24% in the last year. And its annual EPS growth rate over 5 years is 7.0%. This could arguably justify a relatively high P/E ratio.
How Does Lancaster Colony’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. The image below shows that Lancaster Colony has a higher P/E than the average (20) P/E for companies in the food industry.
Its relatively high P/E ratio indicates that Lancaster Colony shareholders think it will perform better than other companies in its industry classification. 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
Don’t forget that the P/E ratio considers market capitalization. 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 taking on debt (or spending its remaining cash).
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.
Lancaster Colony’s Balance Sheet
The extra options and safety that comes with Lancaster Colony’s US$195m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Bottom Line On Lancaster Colony’s P/E Ratio
Lancaster Colony trades on a P/E ratio of 29, which is above the US market average of 17.2. With cash in the bank the company has plenty of growth options — and it is already on the right track. So it is not surprising the market is probably extrapolating recent growth well into the future, reflected in the relatively high P/E ratio.
When the market is wrong about a stock, it gives savvy investors an opportunity. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
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 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.