Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at Ark Restaurants Corp.'s (NASDAQ:ARKR) P/E ratio and reflect on what it tells us about the company's share price. Ark Restaurants has a price to earnings ratio of 16.72, based on the last twelve months. That means that at current prices, buyers pay $16.72 for every $1 in trailing yearly profits.
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Ark Restaurants:
P/E of 16.72 = $20.42 ÷ $1.22 (Based on the trailing twelve months to June 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 isn't necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
Does Ark Restaurants Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. If you look at the image below, you can see Ark Restaurants has a lower P/E than the average (23.3) in the hospitality industry classification.
Its relatively low P/E ratio indicates that Ark Restaurants shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
How Growth Rates Impact P/E Ratios
If earnings fall then in the future the 'E' will be lower. That means unless the share price falls, the P/E will increase in a few years. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
Ark Restaurants shrunk earnings per share by 15% over the last year. And EPS is down 6.2% a year, over the last 3 years. This could justify a low P/E.
Remember: P/E Ratios Don't Consider The Balance Sheet
Don't forget that the P/E ratio considers market capitalization. So it won't reflect the advantage of cash, or disadvantage of debt. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).
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.
Ark Restaurants's Balance Sheet
Ark Restaurants's net debt equates to 30% of its market capitalization. You'd want to be aware of this fact, but it doesn't bother us.
The Bottom Line On Ark Restaurants's P/E Ratio
Ark Restaurants's P/E is 16.7 which is about average (17.8) in the US market. Given it has some debt, but didn't grow last year, the P/E indicates the market is expecting higher profits ahead for the business.
Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. We don't have analyst forecasts, but shareholders might want to examine this detailed historical graph 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.
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 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.