This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll look at CF Industries Holdings, Inc.’s (NYSE:CF) P/E ratio and reflect on what it tells us about the company’s share price. CF Industries Holdings has a P/E ratio of 31.29, based on the last twelve months. That corresponds to an earnings yield of approximately 3.2%.
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 CF Industries Holdings:
P/E of 31.29 = $39.01 ÷ $1.25 (Based on the year 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
Probably the most important factor in determining what P/E a company trades on is the earnings growth. When earnings grow, the ‘E’ increases, over time. That means even if the current P/E is high, it will reduce over time if the share price stays flat. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
CF Industries Holdings shrunk earnings per share by 19% over the last year. But over the longer term (3 years), earnings per share have increased by 14%. And over the longer term (5 years) earnings per share have decreased 38% annually. This might lead to muted expectations.
How Does CF Industries Holdings’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. As you can see below, CF Industries Holdings has a higher P/E than the average company (17.6) in the chemicals industry.
That means that the market expects CF Industries Holdings will outperform other companies in its industry. Clearly the market expects growth, but it isn’t guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
The ‘Price’ in P/E reflects the market capitalization of the company. That means it doesn’t take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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).
Is Debt Impacting CF Industries Holdings’s P/E?
CF Industries Holdings has net debt worth 46% of its market capitalization. If you want to compare its P/E ratio to other companies, you should absolutely keep in mind it has significant borrowings.
The Bottom Line On CF Industries Holdings’s P/E Ratio
CF Industries Holdings has a P/E of 31.3. That’s higher than the average in the US market, which is 17.2. With a bit of debt, but a lack of recent growth, it’s safe to say the market is expecting improved profit performance from the company, in the next few years.
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 report on the analyst consensus forecasts could help you make a master move on this stock.
Of course you might be able to find a better stock than CF Industries Holdings. So you may wish to see this free collection of other companies that have grown earnings strongly.
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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.