It's great to see Elegant Hotels Group (LON:EHG) shareholders have their patience rewarded with a 57% share price pop in the last month. Looking back a bit further, we're also happy to report the stock is up 69% in the last year.
All else being equal, a sharp share price increase should make a stock less attractive to potential investors. In the long term, share prices tend to follow earnings per share, but in the short term prices bounce around in response to short term factors (which are not always obvious). So some would prefer to hold off buying when there is a lot of optimism towards a stock. 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.
Does Elegant Hotels Group Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 10.04 that sentiment around Elegant Hotels Group isn't particularly high. If you look at the image below, you can see Elegant Hotels Group has a lower P/E than the average (24.7) in the hospitality industry classification.
This suggests that market participants think Elegant Hotels Group will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. You should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. When earnings grow, the 'E' increases, over time. And in that case, the P/E ratio itself will drop rather quickly. Then, a lower P/E should attract more buyers, pushing the share price up.
Notably, Elegant Hotels Group grew EPS by a whopping 42% in the last year. And it has improved its earnings per share by 12% per year over the last three years. So we'd generally expect it to have a relatively high P/E ratio. In contrast, EPS has decreased by 3.2%, annually, over 5 years.
Remember: P/E Ratios Don't Consider The Balance Sheet
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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).
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 Elegant Hotels Group's Debt Impact Its P/E Ratio?
Elegant Hotels Group has net debt worth 55% of its market capitalization. This is enough debt that you'd have to make some adjustments before using the P/E ratio to compare it to a company with net cash.
The Verdict On Elegant Hotels Group's P/E Ratio
Elegant Hotels Group trades on a P/E ratio of 10.0, which is below the GB market average of 16.7. The company may have significant debt, but EPS growth was good last year. If the company can continue to grow earnings, then the current P/E may be unjustifiably low. What is very clear is that the market has become more optimistic about Elegant Hotels Group over the last month, with the P/E ratio rising from 6.4 back then to 10.0 today. For those who prefer to invest with the flow of momentum, that might mean it's time to put the stock on a watchlist, or research it. But the contrarian may see it as a missed opportunity.
Investors have an opportunity when market expectations about a stock are wrong. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
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 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.