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Despite Its High P/E Ratio, Is Eddie Stobart Logistics plc (LON:ESL) Still Undervalued?

Simply Wall St

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The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll look at Eddie Stobart Logistics plc's (LON:ESL) P/E ratio and reflect on what it tells us about the company's share price. Looking at earnings over the last twelve months, Eddie Stobart Logistics has a P/E ratio of 16.94. That is equivalent to an earnings yield of about 5.9%.

View our latest analysis for Eddie Stobart Logistics

How Do You Calculate A P/E Ratio?

The formula for P/E is:

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

Or for Eddie Stobart Logistics:

P/E of 16.94 = £0.75 ÷ £0.044 (Based on the trailing twelve months to November 2018.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that investors are paying a higher price for each £1 of company earnings. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.'

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. 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.

In the last year, Eddie Stobart Logistics grew EPS like Taylor Swift grew her fan base back in 2010; the 265% gain was both fast and well deserved. And earnings per share have improved by 40% annually, over the last three years. So we'd absolutely expect it to have a relatively high P/E ratio.

Does Eddie Stobart Logistics 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 Eddie Stobart Logistics has a higher P/E than the average (9.1) P/E for companies in the transportation industry.

AIM:ESL Price Estimation Relative to Market, June 30th 2019

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

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.

How Does Eddie Stobart Logistics's Debt Impact Its P/E Ratio?

Eddie Stobart Logistics has net debt worth 56% of its market capitalization. This is a reasonably significant level of debt -- all else being equal you'd expect a much lower P/E than if it had net cash.

The Bottom Line On Eddie Stobart Logistics's P/E Ratio

Eddie Stobart Logistics's P/E is 16.9 which is about average (16.4) in the GB market. While it does have meaningful debt levels, it has also produced strong earnings growth recently. The P/E suggests the market isn't confident that growth will be sustained, though.

Investors have an opportunity when market expectations about a stock are wrong. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine.' So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

But note: Eddie Stobart Logistics 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.