The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to Charlotte's Web Holdings, Inc.'s (TSE:CWEB), to help you decide if the stock is worth further research. Charlotte's Web Holdings has a price to earnings ratio of 73.85, based on the last twelve months. That means that at current prices, buyers pay CA$73.85 for every CA$1 in trailing yearly profits.

Check out our latest analysis for Charlotte's Web Holdings

How Do I Calculate A Price To Earnings Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)

Or for Charlotte's Web Holdings:

P/E of 73.85 = $4.960 ÷ $0.067 (Based on the trailing twelve months to September 2019.)

(Note: the above calculation uses the share price in the reporting currency, namely USD and the calculation results may not be precise due to rounding.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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 Charlotte's Web Holdings's P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. You can see in the image below that the average P/E (13.7) for companies in the pharmaceuticals industry is a lot lower than Charlotte's Web Holdings's P/E.

TSX:CWEB Price Estimation Relative to Market, March 4th 2020 More

Its relatively high P/E ratio indicates that Charlotte's Web Holdings shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn't guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.

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. Then, a lower P/E should attract more buyers, pushing the share price up.

Charlotte's Web Holdings shrunk earnings per share by 51% over the last year. But over the longer term (5 years) earnings per share have increased by 54%.

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 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.

Charlotte's Web Holdings's Balance Sheet

The extra options and safety that comes with Charlotte's Web Holdings's US$35m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.

The Verdict On Charlotte's Web Holdings's P/E Ratio

Charlotte's Web Holdings's P/E is 73.8 which suggests the market is more focussed on the future opportunity rather than the current level of earnings. The recent drop in earnings per share would make some investors cautious, but the net cash position means the company has time to improve: and the high P/E suggests the market thinks it will.

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