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Despite Its High P/E Ratio, Is LendingTree, Inc. (NASDAQ:TREE) Still Undervalued?

The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). Weâ€™ll look at LendingTree, Inc.â€™s (NASDAQ:TREE) P/E ratio and reflect on what it tells us about the companyâ€™s share price. LendingTree has a P/E ratio of 35.74, based on the last twelve months. In other words, at todayâ€™s prices, investors are paying \$35.74 for every \$1 in prior year profit.

How Do I Calculate A Price To Earnings Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Price per Share Ã· Earnings per Share (EPS)

Or for LendingTree:

P/E of 35.74 = \$312.44 Ã· \$8.74 (Based on the trailing twelve months to December 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 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

P/E ratios primarily reflect market expectations around earnings growth rates. Thatâ€™s because companies that grow earnings per share quickly will rapidly increase the â€˜Eâ€™ in the equation. 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.

Itâ€™s nice to see that LendingTree grew EPS by a stonking 438% in the last year. And it has bolstered its earnings per share by 47% per year over the last five years. Iâ€™d therefore be a little surprised if its P/E ratio was not relatively high.

How Does LendingTreeâ€™s P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. As you can see below, LendingTree has a higher P/E than the average company (15.4) in the mortgage industry.

LendingTreeâ€™s P/E tells us that market participants think the company will perform better than its industry peers, going forward. Clearly the market expects growth, but it isnâ€™t guaranteed. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

Remember: P/E Ratios Donâ€™t Consider The Balance Sheet

Itâ€™s important to note that the P/E ratio considers the market capitalization, not the enterprise value. Thus, the metric does not reflect cash or debt held by the company. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.

Is Debt Impacting LendingTreeâ€™s P/E?

LendingTreeâ€™s net debt is 6.8% of its market cap. So it doesnâ€™t have as many options as it would with net cash, but its debt would not have much of an impact on its P/E ratio.

The Verdict On LendingTreeâ€™s P/E Ratio

LendingTree has a P/E of 35.7. Thatâ€™s higher than the average in the US market, which is 17.7. The company is not overly constrained by its modest debt levels, and it is growing earnings per share. So it does not seem strange that the P/E is above average.

Investors have an opportunity when market expectations about a stock are wrong. As value investor Benjamin Graham famously said, â€˜In the short run, the market is a voting machine but in the long run, it is a weighing machine.â€™ So this free report on the analyst consensus forecasts could help you make a master move on this stock.

Of course you might be able to find a better stock than LendingTree. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.