Interpreting the P/E Ratio Using Real-World Examples
Ladies and Gentlemen… welcome to Byte #3!
Today, we're diving into how to interpret the Price-to-Earnings (P/E) ratio. Most of us know what a P/E ratio is — but do we truly know how to use it effectively in stock analysis?
I've broken it down into a few simple steps for you below. Keep in mind, though: this is just one aspect of analyzing a stock. Many other factors play a role in making informed investment decisions. Here, we are focusing solely on the P/E ratio.
For illustration, I’ll be using two companies: Diageo Plc (DEO) and Brown-Forman Corporation (BF.A).
Disclaimer: This is not investment advice — just a sharing of my thought process!
Why these companies? Both are major players in the beverage industry, which is cyclical in nature. Their performance is closely tied to consumer discretionary spending, and thus to economic expansion and contraction.
Let's break down the interpretation of P/E, step-by-step:
Step 1: What is P/E ratio?
The Price-to-Earnings (P/E) ratio is a valuation metric that compares a company's stock price to its earnings per share (EPS). It’s calculated as:
P/E Ratio = Stock Price\Earnings Per Share (EPS)
Tip: You can find P/E on sites like CNBC, but I prefer stockanalysis.com for its organized tabs, historical data, and easy navigation. 😊
As of April 28, 2025:
DEO: Current TTM P/E = 16.9
BF.A: Current TTM P/E = 16.2
Step 2: What does the P/E ratio tell us?
The P/E ratio shows how much investors are willing to pay for $1 of a company's earnings.
For Diageo, investors are paying $16.99 for every $1 of earnings.
For Brown-Forman, investors are paying $16.21 per $1 of earnings.
Step 3: High vs. Low P/E Ratio
High P/E: Investors expect higher future growth, or the stock may be overvalued.
Low P/E: The stock may be undervalued or have lower growth expectations.
Both DEO and BF.A currently have P/E ratios below the industry average of 23.95, reflecting weak consumer sentiment — worsened by the ongoing threat of tariffs.
Step 4: How to compare P/E Ratios
To interpret the P/E ratio, compare it to:
a) Its historical average
· DEO’s 5-year average P/E: 24.5
b) It’s 5-year High/Low P/E
· DEO 5-year Average High: 28.4, Low: 20.6
c) It’s competitor’s P/E
· BF.A current TTM P/E of 16.2
· Its 5-year average P/E ratio is 34.9
· Its 5-year Average High 42.2 and its Low 30.0 excluding 2020.
Note: 2020 was an outlier year due to COVID and thus excluded from the P/E’s above — sales boomed, skewing the numbers more so for Diageo than Brown-Forman
Step 5: Develop a P/E range
Step 6: Interpretation
Growth Rates: Both companies' low current P/E’s suggest limited growth expectations due to economic sensitivity.
Comparison: Historically, investors have paid more for Brown-Forman’s earnings ($34.90) than for Diageo’s ($24.50) — signaling stronger investor confidence in BF.A with a more consumer defensive portfolio.
Step 7: Is Diageo (DEO) a good investment?
It depends on your view of future prospects. A P/E of 16.9 could be attractive if growth resumes or if tariffs ease and economic conditions improve. DEO could be undervalued today given its wide economic moat and a strong brand portfolio.
Stock Price Projection for 2027:
Inputs:
Current P/E: 16.9
2024 EPS: $6.48
CAGR (2025–2027): 0%(per latest CFRA report)
Future EPS:
6.48 × (1 + 0)^3 = 6.48
Estimated Stock Price in 2027 (assuming P/E of 20.0):
6.48 × 20.0 = $129.60
Potential Gain:
About 17% from today's price of $110.94 over 3 years.
Step 8: Final Considerations
P/E Volatility: Sentiment changes can move P/E ratios.
Revenue Growth: Important to watch, even if EPS growth is flat.
External Factors: Macroeconomic trends, tariffs, and competition could impact outcomes.
Whew, that was a long Byte! Hope you found it helpful. Would love to hear your thoughts!
See you next Monday for another Byte! 😉
