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Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at BJ's Restaurants, Inc.'s (NASDAQ:BJRI) P/E ratio and reflect on what it tells us about the company's share price. Looking at earnings over the last twelve months, BJ's Restaurants has a P/E ratio of 18.22. In other words, at today's prices, investors are paying $18.22 for every $1 in prior year profit.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for BJ's Restaurants:
P/E of 18.22 = $42.37 ÷ $2.33 (Based on the year to April 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each $1 the company has earned over the last year. 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
P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the 'E' increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
BJ's Restaurants shrunk earnings per share by 2.4% last year. But EPS is up 30% over the last 5 years.
Does BJ's Restaurants Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio indicates whether the market has higher or lower expectations of a company. We can see in the image below that the average P/E (22.4) for companies in the hospitality industry is higher than BJ's Restaurants's P/E.
BJ's Restaurants's P/E tells us that market participants think it will not fare as well as its peers in the same industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. You should delve deeper. I like to check if company insiders have been buying or selling.
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. So it won't reflect the advantage of cash, or disadvantage of debt. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
BJ's Restaurants's Balance Sheet
Net debt totals just 8.7% of BJ's Restaurants's market cap. The market might award it a higher P/E ratio if it had net cash, but its unlikely this low level of net borrowing is having a big impact on the P/E multiple.
The Bottom Line On BJ's Restaurants's P/E Ratio
BJ's Restaurants has a P/E of 18.2. That's around the same as the average in the US market, which is 17.7. When you consider the lack of EPS growth last year (along with some debt), it seems the market is optimistic about the future for the business.
Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. 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 BJ's Restaurants. 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).
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 firstname.lastname@example.org. 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.