To the annoyance of some shareholders, SKYCITY Entertainment Group (NZSE:SKC) shares are down a considerable 35% in the last month. That drop has capped off a tough year for shareholders, with the share price down 39% in that time.
Assuming nothing else has changed, a lower share price makes a stock more attractive to potential buyers. 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). The implication here is that long term investors have an opportunity when expectations of a company are too low. One way to gauge market expectations of a stock is to look at its Price to Earnings Ratio (PE Ratio). A high P/E implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.
Does SKYCITY Entertainment Group Have A Relatively High Or Low P/E For Its Industry?
SKYCITY Entertainment Group's P/E of 3.78 indicates relatively low sentiment towards the stock. We can see in the image below that the average P/E (16.2) for companies in the hospitality industry is higher than SKYCITY Entertainment Group's P/E.
Its relatively low P/E ratio indicates that SKYCITY Entertainment Group shareholders think it will struggle to do as well as other companies in its industry classification. Many investors like to buy stocks when the market is pessimistic about their prospects. 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
Earnings growth rates have a big influence on P/E ratios. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
SKYCITY Entertainment Group's earnings made like a rocket, taking off 196% last year. The sweetener is that the annual five year growth rate of 32% is also impressive. So I'd be surprised if the P/E ratio was not above average.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. Thus, the metric does not reflect cash or debt held by the company. 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 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.
SKYCITY Entertainment Group's Balance Sheet
Net debt is 33% of SKYCITY Entertainment Group's market cap. While it's worth keeping this in mind, it isn't a worry.
The Verdict On SKYCITY Entertainment Group's P/E Ratio
SKYCITY Entertainment Group has a P/E of 3.8. That's below the average in the NZ market, which is 17.0. The company hasn't stretched its balance sheet, and earnings growth was good last year. If it continues to grow, then the current low P/E may prove to be unjustified. What can be absolutely certain is that the market has become more pessimistic about SKYCITY Entertainment Group over the last month, with the P/E ratio falling from 5.9 back then to 3.8 today. For those who prefer to invest with the flow of momentum, that might be a bad sign, but for deep value investors this stock might justify some research.
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 visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
Of course you might be able to find a better stock than SKYCITY Entertainment Group. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.
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