The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). To keep it practical, we’ll show how Dover Motorsports, Inc.’s (NYSE:DVD) P/E ratio could help you assess the value on offer. Dover Motorsports has a price to earnings ratio of 6.92, based on the last twelve months. That corresponds to an earnings yield of approximately 14%.
How Do You Calculate A P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Dover Motorsports:
P/E of 6.92 = $1.97 ÷ $0.28 (Based on the year to September 2018.)
Is A High P/E 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 necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
How Growth Rates Impact P/E Ratios
Probably the most important factor in determining what P/E a company trades on is the earnings growth. 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.
It’s nice to see that Dover Motorsports grew EPS by a stonking 160% in the last year. And it has bolstered its earnings per share by 32% per year over the last five years. I’d therefore be a little surprised if its P/E ratio was not relatively high.
How Does Dover Motorsports’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. If you look at the image below, you can see Dover Motorsports has a lower P/E than the average (16.2) in the hospitality industry classification.
Dover Motorsports’s P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Dover Motorsports, it’s quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
Remember: P/E Ratios Don’t Consider The Balance Sheet
Don’t forget that the P/E ratio considers market capitalization. That means it doesn’t take debt or cash into account. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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).
Is Debt Impacting Dover Motorsports’s P/E?
Net debt totals just 0.6% of Dover Motorsports’s market cap. It would probably trade on a higher P/E ratio if it had a lot of cash, but I doubt it is having a big impact.
The Bottom Line On Dover Motorsports’s P/E Ratio
Dover Motorsports has a P/E of 6.9. That’s below the average in the US market, which is 16.5. The company hasn’t stretched its balance sheet, and earnings growth was good last year. If the company can continue to grow earnings, then the current P/E may be unjustifiably low.
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. Although we don’t have analyst forecasts, you might want to assess this data-rich visualization of earnings, revenue and cash flow.
Of course you might be able to find a better stock than Dover Motorsports. So you may wish to see this free collection of other companies that have grown earnings strongly.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.