To the annoyance of some shareholders, Tabcorp Holdings (ASX:TAH) shares are down a considerable 47% in the last month. Indeed the recent decline has arguably caused some bitterness for shareholders who have held through the 49% drop over twelve months.
Assuming nothing else has changed, a lower share price makes a stock more attractive to potential buyers. 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. One way to gauge market expectations of a stock 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.
How Does Tabcorp Holdings's P/E Ratio Compare To Its Peers?
Tabcorp Holdings's P/E of 12.76 indicates relatively low sentiment towards the stock. If you look at the image below, you can see Tabcorp Holdings has a lower P/E than the average (14.4) in the hospitality industry classification.
This suggests that market participants think Tabcorp Holdings 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. You should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. 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.
Tabcorp Holdings's 56% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. Having said that, the average EPS growth over the last three years wasn't so good, coming in at 2.3%. Unfortunately, earnings per share are down 6.1% a year, over 5 years.
Remember: P/E Ratios Don't Consider The Balance Sheet
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. So it won't reflect the advantage of cash, or disadvantage of debt. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
How Does Tabcorp Holdings's Debt Impact Its P/E Ratio?
Tabcorp Holdings has net debt worth 69% of its market capitalization. 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 Bottom Line On Tabcorp Holdings's P/E Ratio
Tabcorp Holdings trades on a P/E ratio of 12.8, which is fairly close to the AU market average of 13.3. It does have enough debt to add risk, although earnings growth was strong in the last year. The P/E suggests the market isn't confident that growth will be sustained, though. What can be absolutely certain is that the market has become significantly less optimistic about Tabcorp Holdings over the last month, with the P/E ratio falling from 24.2 back then to 12.8 today. For those who don't like to trade against momentum, that could be a warning sign, but a contrarian investor might want to take a closer look.
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.
You might be able to find a better buy than Tabcorp Holdings. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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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