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Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at Dave & Buster's Entertainment, Inc.'s (NASDAQ:PLAY) P/E ratio and reflect on what it tells us about the company's share price. Dave & Buster's Entertainment has a P/E ratio of 16.85, based on the last twelve months. That is equivalent to an earnings yield of about 5.9%.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Dave & Buster's Entertainment:
P/E of 16.85 = $50.57 ÷ $3 (Based on the trailing twelve months to February 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 is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about 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 even if the current P/E is high, it will reduce over time if the share price stays flat. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Dave & Buster's Entertainment increased earnings per share by 2.5% last year. And it has bolstered its earnings per share by 115% per year over the last five years.
How Does Dave & Buster's Entertainment's P/E Ratio Compare To Its Peers?
We can get an indication of market expectations by looking at the P/E ratio. We can see in the image below that the average P/E (22.5) for companies in the hospitality industry is higher than Dave & Buster's Entertainment's P/E.
This suggests that market participants think Dave & Buster's Entertainment 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. 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. So it won't reflect the advantage of cash, or disadvantage of debt. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).
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.
Dave & Buster's Entertainment's Balance Sheet
Dave & Buster's Entertainment's net debt is 20% of its market cap. This could bring some additional risk, and reduce the number of investment options for management; worth remembering if you compare its P/E to businesses without debt.
The Verdict On Dave & Buster's Entertainment's P/E Ratio
Dave & Buster's Entertainment trades on a P/E ratio of 16.8, which is fairly close to the US market average of 17.5. With modest debt and some recent earnings growth, it seems likely the market expects a steady performance going forward.
Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with modest (or no) debt, trading on a P/E below 20.
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.