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Despite Its High P/E Ratio, Is Hollywood Bowl Group plc (LON:BOWL) Still Undervalued?

Simply Wall St

Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at Hollywood Bowl Group plc's (LON:BOWL) P/E ratio and reflect on what it tells us about the company's share price. Hollywood Bowl Group has a P/E ratio of 19.33, based on the last twelve months. That means that at current prices, buyers pay £19.33 for every £1 in trailing yearly profits.

See our latest analysis for Hollywood Bowl Group

How Do You Calculate A P/E Ratio?

The formula for P/E is:

Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)

Or for Hollywood Bowl Group:

P/E of 19.33 = £2.42 ÷ £0.13 (Based on the year to September 2018.)

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 a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business's prospects, relative to stocks with a lower P/E.

How Growth Rates Impact P/E Ratios

Probably the most important factor in determining what P/E a company trades on is the earnings growth. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. Then, a lower P/E should attract more buyers, pushing the share price up.

Hollywood Bowl Group increased earnings per share by 2.9% last year. And it has improved its earnings per share by 52% per year over the last three years. Unfortunately, earnings per share are down 6.5% a year, over 5 years.

How Does Hollywood Bowl Group's P/E Ratio Compare To Its Peers?

The P/E ratio indicates whether the market has higher or lower expectations of a company. You can see in the image below that the average P/E (18.4) for companies in the hospitality industry is roughly the same as Hollywood Bowl Group's P/E.

LSE:BOWL Price Estimation Relative to Market, April 22nd 2019

Its P/E ratio suggests that Hollywood Bowl Group shareholders think that in the future it will perform about the same as other companies in its industry classification. So if Hollywood Bowl Group actually outperforms its peers going forward, that should be a positive for the share price. I inform my view byby checking management tenure and remuneration, among other things.

Remember: P/E Ratios Don't Consider The Balance Sheet

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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).

How Does Hollywood Bowl Group's Debt Impact Its P/E Ratio?

Net debt totals just 0.6% of Hollywood Bowl Group's market cap. It would probably trade on a higher P/E ratio if it had a lot of cash, but I doubt it is having a big impact.

The Bottom Line On Hollywood Bowl Group's P/E Ratio

Hollywood Bowl Group's P/E is 19.3 which is above average (16.3) in the GB market. With debt at prudent levels and improving earnings, it's fair to say the market expects steady progress in the future.

When the market is wrong about a stock, it gives savvy investors an opportunity. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. 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.

But note: Hollywood Bowl Group may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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.