Focus on forward P/E ratios

In 1977 rock band Fleetwood Mac’s keyboardist Christine McVie sang, “Don’t stop thinking about tomorrow . . . yesterday’s gone . . . don’t you look back.” Christine was in the aftermath of a divorce and urging herself to focus on the future. That attitude may also have made her a good stock market investor.

At this time of year it’s important to focus on forward-looking P/E ratios.

The market tries to anticipate the future. At this time of the year, it prices companies based on their outlook for 2019—not so much on how they did last year. As a result, looking at trailing P/E (Price-to-Earnings) ratios can lead unsuspecting investors astray. More important are forward-looking P/E ratios.

Consider some of the food stocks that we regularly review on The Back Page. Their trailing P/E ratios are excessive. Their forward P/E ratios, however, may be a bit high, but these two stocks still deserve our ‘hold’ rating.

Scallops are main revenue contributor

Seafood preparation and packaging company Clearwater Seafoods (TSX—CLR) is thought to have earned 22 cents a share in 2018. Based on this estimate, its trailing P/E ratio is an excessive 24.8 times. This year, the company’s earnings are expected to climb by 18.2 per cent, to 26 cents a share. Based on this estimate, its forward P/E ratio is a better, but still hefty, P/E ratio of 21 times.

One drawback with Clearwater is its debt burden. Subtract cash of $26 million from total debt of $472 million and its net debt is $446 million. Divide this by its cash flow of $60 million over the latest four quarters and its net debt-to-cash-flow ratio is 7.4 times. That’s far above our standard comfort zone of two times or less. Bedford, Nova Scotia-based Clearwater remains a hold.

Specialty foods contribute two thirds of revenue

Frozen specialty-food manufacturer Premium Brands Holdings (TSX—PBH) is thought to have earned $3.36 a share in 2018. This gives the stock an excessive trailing P/E ratio of 23.3 times. This year, the company’s earnings are expected to advance by almost 35 per cent, to $4.53 a share. Based on this estimate, the shares trade at a better forward P/E ratio of 17.3 times.

Premium’s net debt-to-cash-flow ratio is a high 7.6 times. This cuts its financial flexibility.

Since we published our August 24, 2018 issue, Premium’s shares have plunged by nearly 21 per cent—much more than the market. This gives the shares negative price momentum. That means that the shares could fall further. Richmond, British Columbia-based Premium remains a hold.

This is an edited version of an article that was originally published for subscribers in the January 25, 2019, issue of The Investment Reporter. You can profit from the award-winning advice subscribers receive regularly in The Investment Reporter.

The Investment Reporter, MPL Communications Inc.
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