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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 Foley Family Wines Limited's (NZSE:FWL) P/E ratio and reflect on what it tells us about the company's share price. Based on the last twelve months, Foley Family Wines's P/E ratio is 31.87. That corresponds to an earnings yield of approximately 3.1%.
View our latest analysis for Foley Family Wines
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 Foley Family Wines:
P/E of 31.87 = NZ$1.91 ÷ NZ$0.060 (Based on the year to December 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each NZ$1 of company earnings. 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
P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the 'E' increases, over time. That means unless the share price increases, the P/E will reduce in a few years. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Foley Family Wines shrunk earnings per share by 15% over the last year. But over the longer term (5 years) earnings per share have increased by 1.3%.
Does Foley Family Wines Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio indicates whether the market has higher or lower expectations of a company. As you can see below, Foley Family Wines has a higher P/E than the average company (24.2) in the beverage industry.
That means that the market expects Foley Family Wines will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. So investors should delve deeper. I like to check if company insiders have been buying or selling.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. So it won't reflect the advantage of cash, or disadvantage of debt. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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.