This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). To keep it practical, we’ll show how Royal Caribbean Cruises Ltd.’s (NYSE:RCL) P/E ratio could help you assess the value on offer. Based on the last twelve months, Royal Caribbean Cruises’s P/E ratio is 13.77. In other words, at today’s prices, investors are paying $13.77 for every $1 in prior year profit.
How Do You Calculate Royal Caribbean Cruises’s P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Royal Caribbean Cruises:
P/E of 13.77 = $118.46 ÷ $8.6 (Based on the trailing twelve months to December 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each $1 of company earnings. 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
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. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
It’s great to see that Royal Caribbean Cruises grew EPS by 14% in the last year. And it has bolstered its earnings per share by 29% per year over the last five years. With that performance, you might expect an above average P/E ratio.
How Does Royal Caribbean Cruises’s P/E Ratio Compare To Its Peers?
The P/E ratio essentially measures market expectations of a company. We can see in the image below that the average P/E (19.8) for companies in the hospitality industry is higher than Royal Caribbean Cruises’s P/E.
This suggests that market participants think Royal Caribbean Cruises will underperform other companies in its industry. Since the market seems unimpressed with Royal Caribbean Cruises, it’s quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and selling.
Remember: P/E Ratios Don’t Consider The Balance Sheet
Don’t forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. Theoretically, a business can improve its earnings (and produce a lower P/E in the future), by taking on debt (or spending its remaining cash).
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.
Is Debt Impacting Royal Caribbean Cruises’s P/E?
Royal Caribbean Cruises has net debt worth 42% of its market capitalization. This is a reasonably significant level of debt — all else being equal you’d expect a much lower P/E than if it had net cash.
The Bottom Line On Royal Caribbean Cruises’s P/E Ratio
Royal Caribbean Cruises’s P/E is 13.8 which is below average (17.7) in the US market. The company hasn’t stretched its balance sheet, and earnings growth was good last year. The low P/E ratio suggests current market expectations are muted, implying these levels of growth will not continue. Since analysts are predicting growth will continue, one might expect to see a higher P/E so it may be worth looking closer.
Investors should be looking to buy stocks that the market is wrong about. 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 report on the analyst consensus forecasts could help you make a master move on this stock.
Of course you might be able to find a better stock than Royal Caribbean Cruises. 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 firstname.lastname@example.org. 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.