Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at World Wrestling Entertainment, Inc.'s (NYSE:WWE) P/E ratio and reflect on what it tells us about the company's share price. Looking at earnings over the last twelve months, World Wrestling Entertainment has a P/E ratio of 74.82. That is equivalent to an earnings yield of about 1.3%.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for World Wrestling Entertainment:
P/E of 74.82 = $96.1 ÷ $1.28 (Based on the trailing twelve months to December 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.'
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. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.
In the last year, World Wrestling Entertainment grew EPS like Taylor Swift grew her fan base back in 2010; the 202% gain was both fast and well deserved. The cherry on top is that the five year growth rate was an impressive 103% per year. So I'd be surprised if the P/E ratio was not above average.
Does World Wrestling Entertainment Have A Relatively High Or Low P/E For Its Industry?
We can get an indication of market expectations by looking at the P/E ratio. You can see in the image below that the average P/E (23.2) for companies in the entertainment industry is a lot lower than World Wrestling Entertainment's P/E.
World Wrestling Entertainment's P/E tells us that market participants think the company will perform better than its industry peers, going forward. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. That means it doesn't take debt or cash into account. 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.
So What Does World Wrestling Entertainment's Balance Sheet Tell Us?
The extra options and safety that comes with World Wrestling Entertainment's US$145m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Bottom Line On World Wrestling Entertainment's P/E Ratio
World Wrestling Entertainment's P/E is 74.8 which suggests the market is more focussed on the future opportunity rather than the current level of earnings. Its net cash position is the cherry on top of its superb EPS growth. So based on this analysis we'd expect World Wrestling Entertainment to have a high P/E ratio.
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. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
Of course you might be able to find a better stock than World Wrestling Entertainment. So you may wish to see this free collection of other companies that have grown earnings strongly.
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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.