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Should You Be Tempted To Sell Loblaw Companies Limited (TSE:L) Because Of Its P/E Ratio?

Simply Wall St

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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 apply a basic P/E ratio analysis to Loblaw Companies Limited's (TSE:L), to help you decide if the stock is worth further research. Based on the last twelve months, Loblaw Companies's P/E ratio is 37.38. In other words, at today's prices, investors are paying CA$37.38 for every CA$1 in prior year profit.

View our latest analysis for Loblaw Companies

How Do You Calculate Loblaw Companies's P/E Ratio?

The formula for P/E is:

Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)

Or for Loblaw Companies:

P/E of 37.38 = CA$69.36 ÷ CA$1.86 (Based on the trailing twelve months to March 2019.)

Is A High Price-to-Earnings Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing 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

Probably the most important factor in determining what P/E a company trades on is the earnings growth. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

Loblaw Companies shrunk earnings per share by 42% over the last year. But over the longer term (3 years), earnings per share have increased by 6.1%. And EPS is down 1.4% a year, over the last 5 years. This might lead to muted expectations.

Does Loblaw Companies 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. The image below shows that Loblaw Companies has a higher P/E than the average (22) P/E for companies in the consumer retailing industry.

TSX:L Price Estimation Relative to Market, June 2nd 2019

Its relatively high P/E ratio indicates that Loblaw Companies shareholders think it will perform better than other companies in its industry classification. 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.

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.

While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.

How Does Loblaw Companies's Debt Impact Its P/E Ratio?

Loblaw Companies has net debt worth 61% of its market capitalization. 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.

The Verdict On Loblaw Companies's P/E Ratio

Loblaw Companies's P/E is 37.4 which is above average (14.9) in the CA market. With relatively high debt, and no earnings per share growth over twelve months, it's safe to say the market believes the company will improve its earnings growth in the future.

When the market is wrong about a stock, it gives savvy investors an opportunity. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

But note: Loblaw Companies may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. Simply Wall St has no position in the stocks mentioned. Thank you for reading.