This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll show how you can use Del Taco Restaurants, Inc.'s (NASDAQ:TACO) P/E ratio to inform your assessment of the investment opportunity. Del Taco Restaurants has a price to earnings ratio of 19.96, based on the last twelve months. That means that at current prices, buyers pay $19.96 for every $1 in trailing yearly profits.
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 Del Taco Restaurants:
P/E of 19.96 = $9.93 ÷ $0.50 (Based on the year to January 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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
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. That means even if the current P/E is high, it will reduce over time if the share price stays flat. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Del Taco Restaurants shrunk earnings per share by 61% over the last year. But over the longer term (3 years), earnings per share have increased by 32%.
How Does Del Taco Restaurants's P/E Ratio Compare To Its Peers?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. The image below shows that Del Taco Restaurants has a lower P/E than the average (23.9) P/E for companies in the hospitality industry.
This suggests that market participants think Del Taco Restaurants will underperform other companies in its industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The 'Price' in P/E reflects the market capitalization of the company. 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.
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
So What Does Del Taco Restaurants's Balance Sheet Tell Us?
Net debt is 47% of Del Taco Restaurants's market cap. While that's enough to warrant consideration, it doesn't really concern us.
The Verdict On Del Taco Restaurants's P/E Ratio
Del Taco Restaurants has a P/E of 20. That's higher than the average in the US market, which is 18.2. With some debt but no EPS growth last year, the market has high expectations of future profits.
Investors should be looking to buy stocks that the market is wrong about. 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 Del Taco Restaurants. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.