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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we'll show how Bakkavor Group plc's (LON:BAKK) P/E ratio could help you assess the value on offer. Bakkavor Group has a price to earnings ratio of 11.26, based on the last twelve months. That means that at current prices, buyers pay £11.26 for every £1 in trailing yearly profits.
View our latest analysis for Bakkavor 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 Bakkavor Group:
P/E of 11.26 = £1.31 ÷ £0.12 (Based on the year to December 2018.)
Is A High P/E Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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. Then, a higher P/E might scare off shareholders, pushing the share price down.
Bakkavor Group's earnings made like a rocket, taking off 99% last year. Unfortunately, earnings per share are down 28% a year, over 3 years.
How Does Bakkavor Group's P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. We can see in the image below that the average P/E (19.7) for companies in the food industry is higher than Bakkavor Group's P/E.
Its relatively low P/E ratio indicates that Bakkavor Group shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Bakkavor Group, it's quite possible it could surprise on the upside. You 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. That means it doesn't take debt or cash into account. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.