In This Article:
Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll show how you can use The Heavitree Brewery PLC's (LON:HVTA) P/E ratio to inform your assessment of the investment opportunity. Looking at earnings over the last twelve months, Heavitree Brewery has a P/E ratio of 7.85. In other words, at today's prices, investors are paying £7.85 for every £1 in prior year profit.
See our latest analysis for Heavitree Brewery
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Heavitree Brewery:
P/E of 7.85 = £2.20 ÷ £0.28 (Based on the trailing twelve months to April 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each £1 of company earnings. 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 Does Heavitree Brewery's P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. We can see in the image below that the average P/E (23.8) for companies in the hospitality industry is higher than Heavitree Brewery's P/E.
Its relatively low P/E ratio indicates that Heavitree Brewery shareholders think it will struggle to do as well as other companies in its industry classification. Many investors like to buy stocks when the market is pessimistic about their prospects. You should delve deeper. I like to check if company insiders have been buying or selling.
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. 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.
Heavitree Brewery shrunk earnings per share by 35% over the last year. But it has grown its earnings per share by 9.2% per year over the last five years.
Remember: P/E Ratios Don't Consider The Balance Sheet
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).