Why Tredegar Corporation’s (NYSE:TG) High P/E Ratio Isn’t Necessarily A Bad Thing

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Today, we’ll introduce the concept of the P/E ratio for those who are learning about investing. We’ll look at Tredegar Corporation’s (NYSE:TG) P/E ratio and reflect on what it tells us about the company’s share price. Based on the last twelve months, Tredegar’s P/E ratio is 24.53. In other words, at today’s prices, investors are paying $24.53 for every $1 in prior year profit.

See our latest analysis for Tredegar

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 Tredegar:

P/E of 24.53 = $18.43 ÷ $0.75 (Based on the trailing twelve months to December 2018.)

Is A High P/E 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 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. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. And in that case, the P/E ratio itself will drop rather quickly. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

Tredegar saw earnings per share decrease by 35% last year. And it has shrunk its earnings per share by 7.6% per year over the last five years. This growth rate might warrant a below average P/E ratio.

Does Tredegar 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. The image below shows that Tredegar has a higher P/E than the average (18.7) P/E for companies in the chemicals industry.

NYSE:TG Price Estimation Relative to Market, April 30th 2019
NYSE:TG Price Estimation Relative to Market, April 30th 2019

That means that the market expects Tredegar will outperform other companies in its industry. The market is optimistic about the future, but that doesn’t guarantee future growth. So investors should delve deeper. I like to check if company insiders have been buying or 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. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

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.

Is Debt Impacting Tredegar’s P/E?

Tredegar has net debt worth 11% of its market capitalization. That’s enough debt to impact the P/E ratio a little; so keep it in mind if you’re comparing it to companies without debt.

The Bottom Line On Tredegar’s P/E Ratio

Tredegar’s P/E is 24.5 which is above average (18.3) in the US market. 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. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. We don’t have analyst forecasts, but you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.

Of course you might be able to find a better stock than Tredegar. 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 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.