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Does Ark Restaurants Corp.'s (NASDAQ:ARKR) P/E Ratio Signal A Buying Opportunity?

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Of late the Ark Restaurants (NASDAQ:ARKR) share price has softened like an ice cream in the sun, melting a full . But there's still good reason for shareholders to be content; the stock has gained 5.2% in the last 90 days. The stock has been solid, longer term, gaining 22% in the last year.

Assuming no other changes, a sharply higher share price makes a stock less attractive to potential buyers. While the market sentiment towards a stock is very changeable, in the long run, the share price will tend to move in the same direction as earnings per share. The implication here is that deep value investors might steer clear when expectations of a company are too high. Perhaps the simplest way to get a read on investors' expectations of a business is to look at its Price to Earnings Ratio (PE Ratio). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.

See our latest analysis for Ark Restaurants

How Does Ark Restaurants's P/E Ratio Compare To Its Peers?

Ark Restaurants's P/E of 28.64 indicates some degree of optimism towards the stock. The image below shows that Ark Restaurants has a higher P/E than the average (25.0) P/E for companies in the hospitality industry.

NasdaqGM:ARKR Price Estimation Relative to Market, January 3rd 2020
NasdaqGM:ARKR Price Estimation Relative to Market, January 3rd 2020

Ark Restaurants'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 isn't guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.

How Growth Rates Impact P/E Ratios

If earnings fall then in the future the 'E' will be lower. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.

Ark Restaurants shrunk earnings per share by 43% over the last year. And it has shrunk its earnings per share by 12% per year over the last five years. This growth rate might warrant a below average P/E ratio.

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

Don't forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.

How Does Ark Restaurants's Debt Impact Its P/E Ratio?

Ark Restaurants has net debt worth 25% of its market capitalization. This could bring some additional risk, and reduce the number of investment options for management; worth remembering if you compare its P/E to businesses without debt.

The Verdict On Ark Restaurants's P/E Ratio

Ark Restaurants's P/E is 28.6 which is above average (18.9) in its market. With modest debt but no EPS growth in the last year, it's fair to say the P/E implies some optimism about future earnings, from the market. What can be absolutely certain is that the market has become less optimistic about Ark Restaurants over the last month, with the P/E ratio falling from 28.6 back then to 28.6 today. For those who prefer to invest with the flow of momentum, that might be a bad sign, but for a contrarian, it may signal opportunity.

Investors have an opportunity when market expectations about a stock are wrong. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. We don't have analyst forecasts, but you might want to assess this data-rich visualization of earnings, revenue and cash flow.

Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.

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.

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. Thank you for reading.