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Is Melco Resorts & Entertainment Limited's (NASDAQ:MLCO) High P/E Ratio A Problem For Investors?

Simply Wall St

The goal of this article is to teach you how to use price to earnings ratios (P/E ratios). We'll apply a basic P/E ratio analysis to Melco Resorts & Entertainment Limited's (NASDAQ:MLCO), to help you decide if the stock is worth further research. Melco Resorts & Entertainment has a P/E ratio of 26.43, based on the last twelve months. That is equivalent to an earnings yield of about 3.8%.

View our latest analysis for Melco Resorts & Entertainment

How Do You Calculate A P/E Ratio?

The formula for P/E is:

Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)

Or for Melco Resorts & Entertainment:

P/E of 26.43 = $20.04 ÷ $0.76 (Based on the trailing twelve months to June 2019.)

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. 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 Does Melco Resorts & Entertainment's P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. As you can see below, Melco Resorts & Entertainment has a higher P/E than the average company (22.8) in the hospitality industry.

NasdaqGS:MLCO Price Estimation Relative to Market, August 19th 2019

That means that the market expects Melco Resorts & Entertainment will outperform other companies in its industry. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should delve deeper. I like to check if company insiders have been buying or selling.

How Growth Rates Impact P/E Ratios

P/E ratios primarily reflect market expectations around earnings growth rates. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.

Melco Resorts & Entertainment saw earnings per share decrease by 9.6% last year. But over the longer term (3 years), earnings per share have increased by 64%. And it has shrunk its earnings per share by 12% per year over the last five years. So you wouldn't expect a very high P/E.

Don't Forget: The P/E Does Not Account For Debt or Bank Deposits

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. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.

So What Does Melco Resorts & Entertainment's Balance Sheet Tell Us?

Melco Resorts & Entertainment's net debt equates to 34% of its market capitalization. While it's worth keeping this in mind, it isn't a worry.

The Bottom Line On Melco Resorts & Entertainment's P/E Ratio

Melco Resorts & Entertainment trades on a P/E ratio of 26.4, which is above its market average of 17.2. With modest debt but no EPS growth in the last year, it's fair to say the P/E implies some optimism about future earnings, from the market.

When the market is wrong about a stock, it gives savvy investors an opportunity. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine.' 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 Melco Resorts & Entertainment. 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 editorial-team@simplywallst.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.