This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll look at Carnival Corporation's (NYSE:CCL) P/E ratio and reflect on what it tells us about the company's share price. Looking at earnings over the last twelve months, Carnival has a P/E ratio of 12.44. In other words, at today's prices, investors are paying $12.44 for every $1 in prior year profit.
How Do I Calculate Carnival's Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Carnival:
P/E of 12.44 = $54.8 ÷ $4.41 (Based on the trailing twelve months to February 2019.)
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. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. Earnings growth means that in the future the 'E' will be higher. And in that case, the P/E ratio itself will drop rather quickly. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
It's great to see that Carnival grew EPS by 20% in the last year. And its annual EPS growth rate over 5 years is 27%. This could arguably justify a relatively high P/E ratio.
How Does Carnival's P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. We can see in the image below that the average P/E (23.9) for companies in the hospitality industry is higher than Carnival's P/E.
This suggests that market participants think Carnival will underperform other companies in its industry. Since the market seems unimpressed with Carnival, it's quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
Remember: P/E Ratios Don't Consider The Balance Sheet
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. In other words, it does not consider any debt or cash that the company may have on the balance sheet. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
Carnival's Balance Sheet
Carnival's net debt equates to 29% of its market capitalization. While it's worth keeping this in mind, it isn't a worry.
The Verdict On Carnival's P/E Ratio
Carnival trades on a P/E ratio of 12.4, which is below the US market average of 18.2. The company does have a little debt, and EPS growth was good last year. The low P/E ratio suggests current market expectations are muted, implying these levels of growth will not continue.
Investors have an opportunity when market expectations about a stock are wrong. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
You might be able to find a better buy than Carnival. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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If you spot an error that warrants correction, please contact the editor at email@example.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.