Should We Worry About FirstFarms A/S's (CPH:FFARMS) P/E Ratio?

Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at FirstFarms A/S's (CPH:FFARMS) P/E ratio and reflect on what it tells us about the company's share price. What is FirstFarms's P/E ratio? Well, based on the last twelve months it is 28.30. That is equivalent to an earnings yield of about 3.5%.

See our latest analysis for FirstFarms

How Do You Calculate A P/E Ratio?

The formula for price to earnings is:

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

Or for FirstFarms:

P/E of 28.30 = DKK60.00 ÷ DKK2.12 (Based on the year to September 2019.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each DKK1 of company earnings. That isn't necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.

How Does FirstFarms's P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. The image below shows that FirstFarms has a higher P/E than the average (18.2) P/E for companies in the food industry.

FirstFarms'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 investors 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. 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. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

FirstFarms increased earnings per share by an impressive 15% over the last twelve months. And earnings per share have improved by 2.0% annually, over the last five years. This could arguably justify a relatively high P/E ratio.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

The 'Price' in P/E reflects the market capitalization of the company. So it won't reflect the advantage of cash, or disadvantage of debt. 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.

FirstFarms's Balance Sheet

FirstFarms's net debt is considerable, at 128% of its market cap. If you want to compare its P/E ratio to other companies, you must keep in mind that these debt levels would usually warrant a relatively low P/E.

The Verdict On FirstFarms's P/E Ratio

FirstFarms has a P/E of 28.3. That's higher than the average in its market, which is 15.8. It's good to see the recent earnings growth, although we note the company uses debt already. The relatively high P/E ratio suggests shareholders think growth will continue.

Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. Although we don't have analyst forecasts shareholders might want to examine this detailed historical graph of earnings, revenue and cash flow.

You might be able to find a better buy than FirstFarms. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

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.

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. Thank you for reading.