Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at SKYCITY Entertainment Group Limited's (NZSE:SKC) P/E ratio and reflect on what it tells us about the company's share price. Based on the last twelve months, SKYCITY Entertainment Group's P/E ratio is 16.05. That is equivalent to an earnings yield of about 6.2%.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for SKYCITY Entertainment Group:
P/E of 16.05 = NZ$3.82 ÷ NZ$0.24 (Based on the trailing twelve months to June 2019.)
Is A High Price-to-Earnings Ratio Good?
The higher the P/E ratio, the higher the price tag of a business, relative to its trailing earnings. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.'
Does SKYCITY Entertainment Group Have A Relatively High Or Low P/E For Its Industry?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. We can see in the image below that the average P/E (21.8) for companies in the hospitality industry is higher than SKYCITY Entertainment Group's P/E.
SKYCITY Entertainment Group's P/E tells us that market participants think it will not fare as well as its peers in the same industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. You should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
SKYCITY Entertainment Group's earnings per share were pretty steady over the last year. But EPS is up 7.0% over the last 5 years.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
Don't forget that the P/E ratio considers market capitalization. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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).
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
How Does SKYCITY Entertainment Group's Debt Impact Its P/E Ratio?
SKYCITY Entertainment Group's net debt is 21% 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 SKYCITY Entertainment Group's P/E Ratio
SKYCITY Entertainment Group has a P/E of 16.1. That's below the average in the NZ market, which is 18.3. The company hasn't stretched its balance sheet, and earnings are improving. The P/E ratio implies the market is cautious about longer term prospects.
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.
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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.