P/E Ratio Demystified. Spot a Bargain with a Low P/E Ratio

by Hank Coleman

You can use a company’s Price to Earnings Ratio to quickly gauge its value relative to the overall market or its industry. For this example, we will compare Coca-Cola (Stock Symbol: KO) and Dr. Pepper. Coke’s P/E Ratio is currently 21.6. Today’s price for the stock is $53.38 and it earned $2.47 per share (EPS) this past year.

Price / Earnings Per Share = P/E Ratio
Coke: $53.38 / $2.47 = 21.6 P/E Ratio

Remember not to only compare apples to oranges when looking at price and earnings. If you compute the ratio using per share data, use it all the way through the calculations.

This past summer Dr. Pepper Snapple (Stock Symbol: DPS) broke away from Cadbury Schweppes and formed its own stand alone entity. Dr. Pepper’s P/E Ratio is currently 13.1. The stock’s price is $25.61 and it earned $1.95 per share (EPS) last year.

Dr. Pepper: $25.61 / $1.95 = 13.1 P/E Ratio

If Coca-Cola and its 21.6 P/E Ratio are the benchmarks for the soft drink industry, then Dr. Pepper’s shares are undervalued. Dr. Pepper Snapple should be priced closer to $39 per share.

For example: Unknown Price / $1.95 = 20 P/E Ratio; Solve for Price you and get 20 x $1.95 or a fair market value of $39 per share for the company.

Is Dr. Pepper the same kind of company as Coke or Pepsi? No, the do not have the worldwide branding of the two soda giants, but they are not similar to one of Coca-Cola’s bottlers, who have a P/E Ratios of 13, either. Dr. Pepper is some where in between 13 and 20. They should be valued more closely to a company like National Beverage Company, the makers of Rip-It Energy Drink and Shasta. National Beverage Company has a P/E Ratio of 18. A metric like that would put Dr. Pepper’s stock value at a much higher $35 than the market’s current rate. If the company can continue to post solid earnings per share numbers, I expect to see the market correct Dr. Pepper’s undervalued stock price in the next year or so.

Disclaimer: The author owns stock in one or more of the companies mentioned in this posting. No writings in the blog constitutes specific buy, sell, or hold advice. You should seek advice before acting from a qualified finance professional.

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