Why Vector Group Ltd.'s (NYSE:VGR) High P/E Ratio Isn't Necessarily A Bad Thing

This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll show how you can use Vector Group Ltd.'s (NYSE:VGR) P/E ratio to inform your assessment of the investment opportunity. What is Vector Group's P/E ratio? Well, based on the last twelve months it is 28.92. That corresponds to an earnings yield of approximately 3.5%.

See our latest analysis for Vector Group

How Do You Calculate A P/E Ratio?

The formula for price to earnings is:

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

Or for Vector Group:

P/E of 28.92 = $10.6 ÷ $0.37 (Based on the trailing twelve months to December 2018.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each $1 of company earnings. 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

Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.

Vector Group saw earnings per share decrease by 35% last year. But it has grown its earnings per share by 3.4% per year over the last five years. And it has shrunk its earnings per share by 4.5% per year over the last three years. This growth rate might warrant a low P/E ratio.

Does Vector Group Have A Relatively High Or Low P/E For Its Industry?

The P/E ratio essentially measures market expectations of a company. As you can see below, Vector Group has a higher P/E than the average company (16.1) in the tobacco industry.

That means that the market expects Vector Group will outperform other companies in its industry. Clearly the market expects growth, but it isn't guaranteed. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

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.

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).

So What Does Vector Group's Balance Sheet Tell Us?

Vector Group has net debt worth 62% of its market capitalization. This is a reasonably significant level of debt -- all else being equal you'd expect a much lower P/E than if it had net cash.

The Verdict On Vector Group's P/E Ratio

Vector Group's P/E is 28.9 which is above average (18) in the US market. With significant debt and no EPS growth last year, shareholders are betting on an improvement in earnings from the company.

When the market is wrong about a stock, it gives savvy investors an opportunity. 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 freevisualization 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 Vector Group. So you may wish to see this freecollection 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.