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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 Imperial Brands PLC’s (LON:IMB) P/E ratio to inform your assessment of the investment opportunity. Imperial Brands has a P/E ratio of 16.52, based on the last twelve months. That corresponds to an earnings yield of approximately 6.1%.
See our latest analysis for Imperial Brands
How Do I Calculate Imperial Brands’s Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Imperial Brands:
P/E of 16.52 = £23.73 ÷ £1.44 (Based on the trailing twelve months to September 2018.)
Is A High Price-to-Earnings 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 is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.
Imperial Brands shrunk earnings per share by 2.7% last year. But over the longer term (5 years) earnings per share have increased by 2.0%.
How Does Imperial Brands’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. You can see in the image below that the average P/E (13.5) for companies in the tobacco industry is lower than Imperial Brands’s P/E.
Imperial Brands’s P/E tells us that market participants think the company will perform better than its industry peers, going forward. Shareholders are clearly optimistic, but the future is always uncertain. So further research is always essential. I often monitor director buying and 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.
How Does Imperial Brands’s Debt Impact Its P/E Ratio?
Imperial Brands’s net debt is 49% of its market cap. This is enough debt that you’d have to make some adjustments before using the P/E ratio to compare it to a company with net cash.