The Kraft Heinz Company (NASDAQ:KHC) is trading with a trailing P/E of 23x, which is higher than the industry average of 20.7x. Although some investors may jump to the conclusion that you should avoid the stock or sell if you own it, understanding the assumptions behind the P/E ratio might change your mind. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for. Check out our latest analysis for Kraft Heinz
What you need to know about the P/E ratio
P/E is a popular ratio used for relative valuation. By comparing a stock’s price per share to its earnings per share, we are able to see how much investors are paying for each dollar of the company’s earnings.
P/E Calculation for KHC
Price-Earnings Ratio = Price per share ÷ Earnings per share
KHC Price-Earnings Ratio = $74.31 ÷ $3.233 = 23x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. We want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as KHC, such as size and country of operation. A quick method of creating a peer group is to use companies in the same industry, which is what I will do. KHC’s P/E of 23x is higher than its industry peers (20.7x), which implies that each dollar of KHC’s earnings is being overvalued by investors. Therefore, according to this analysis, KHC is an over-priced stock.
Assumptions to watch out for
Before you jump to the conclusion that KHC should be banished from your portfolio, it is important to realise that our conclusion rests on two assertions. Firstly, our peer group contains companies that are similar to KHC. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared lower risk firms with KHC, then investors would naturally value it at a lower price since it is a riskier investment. The second assumption that must hold true is that the stocks we are comparing KHC to are fairly valued by the market. If this does not hold, there is a possibility that KHC’s P/E is lower because our peer group is overvalued by the market.
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.