This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we'll show how Ten Entertainment Group plc's (LON:TEG) P/E ratio could help you assess the value on offer. Looking at earnings over the last twelve months, Ten Entertainment Group has a P/E ratio of 21.40. That corresponds to an earnings yield of approximately 4.7%.
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 Ten Entertainment Group:
P/E of 21.40 = £2.96 ÷ £0.14 (Based on the year 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. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
Does Ten 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. If you look at the image below, you can see Ten Entertainment Group has a lower P/E than the average (27.2) in the hospitality industry classification.
Its relatively low P/E ratio indicates that Ten Entertainment Group shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Ten Entertainment Group, it's quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
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. And in that case, the P/E ratio itself will drop rather quickly. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
Ten Entertainment Group increased earnings per share by 4.9% last year. And earnings per share have improved by 35% annually, over the last three years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The 'Price' in P/E reflects the market capitalization of the company. So it won't reflect the advantage of cash, or disadvantage of debt. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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).
So What Does Ten Entertainment Group's Balance Sheet Tell Us?
Ten Entertainment Group's net debt is 1.6% of its market cap. The market might award it a higher P/E ratio if it had net cash, but its unlikely this low level of net borrowing is having a big impact on the P/E multiple.
The Verdict On Ten Entertainment Group's P/E Ratio
Ten Entertainment Group trades on a P/E ratio of 21.4, which is above its market average of 18.0. With modest debt relative to its size, and modest earnings growth, the market is likely expecting sustained long-term growth, if not a near-term improvement.
Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
You might be able to find a better buy than Ten Entertainment Group. 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 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.
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