Unfortunately for some shareholders, the Restaurant Brands International (NYSE:QSR) share price has dived 31% in the last thirty days. That drop has capped off a tough year for shareholders, with the share price down 38% in that time.
All else being equal, a share price drop should make a stock more attractive to potential investors. While the market sentiment towards a stock is very changeable, in the long run, the share price will tend to move in the same direction as earnings per share. The implication here is that long term investors have an opportunity when expectations of a company are too low. Perhaps the simplest way to get a read on investors' expectations of a business is to look at its Price to Earnings Ratio (PE Ratio). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.
Does Restaurant Brands International Have A Relatively High Or Low P/E For Its Industry?
Restaurant Brands International's P/E of 16.89 indicates some degree of optimism towards the stock. You can see in the image below that the average P/E (12.1) for companies in the hospitality industry is lower than Restaurant Brands International's P/E.
Its relatively high P/E ratio indicates that Restaurant Brands International shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn't guaranteed. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. 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.
Restaurant Brands International saw earnings per share decrease by 2.4% last year. But over the longer term (3 years), earnings per share have increased by 17%.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don't forget that the P/E ratio considers market capitalization. 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.
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.
Restaurant Brands International's Balance Sheet
Restaurant Brands International's net debt is 56% of its market cap. This is enough debt that you'd have to make some adjustments before using the P/E ratio to compare it to a company with net cash.
The Verdict On Restaurant Brands International's P/E Ratio
Restaurant Brands International has a P/E of 16.9. That's higher than the average in its market, which is 13.0. With meaningful debt and a lack of recent earnings growth, the market has high expectations that the business will earn more in the future. What can be absolutely certain is that the market has become significantly less optimistic about Restaurant Brands International over the last month, with the P/E ratio falling from 24.4 back then to 16.9 today. For those who prefer to invest with the flow of momentum, that might be a bad sign, but for a contrarian, it may signal opportunity.
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 report on the analyst consensus forecasts could help you make a master move on this stock.
But note: Restaurant Brands International may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
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.
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