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Why The Star Entertainment Group Limited’s (ASX:SGR) High P/E Ratio Isn’t Necessarily A Bad Thing

This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll show how you can use The Star Entertainment Group Limited’s (ASX:SGR) P/E ratio to inform your assessment of the investment opportunity. Star Entertainment Group has a P/E ratio of 26.12, based on the last twelve months. In other words, at today’s prices, investors are paying A$26.12 for every A$1 in prior year profit.

Check out our latest analysis for Star Entertainment Group

How Do I Calculate A Price To Earnings Ratio?

The formula for price to earnings is:

Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)

Or for Star Entertainment Group:

P/E of 26.12 = A$4.58 ÷ A$0.18 (Based on the year to June 2018.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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

Probably the most important factor in determining what P/E a company trades on is the earnings growth. When earnings grow, the ‘E’ increases, over time. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.

Star Entertainment Group’s earnings per share fell by 45% in the last twelve months. But over the longer term (5 years) earnings per share have increased by 17%.

How Does Star Entertainment Group’s P/E Ratio Compare To Its Peers?

The P/E ratio essentially measures market expectations of a company. You can see in the image below that the average P/E (21.9) for companies in the hospitality industry is lower than Star Entertainment Group’s P/E.

ASX:SGR PE PEG Gauge December 10th 18

Star Entertainment Group’s P/E tells us that market participants think the company will perform better than its industry peers, going forward. Clearly the market expects growth, but it isn’t guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.

Remember: P/E Ratios Don’t Consider The Balance Sheet

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 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 Star Entertainment Group’s Debt Impact Its P/E Ratio?

Star Entertainment Group’s net debt is 17% 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 Bottom Line On Star Entertainment Group’s P/E Ratio

Star Entertainment Group trades on a P/E ratio of 26.1, which is above the AU market average of 15.1. With some debt but no EPS growth last year, the market has high expectations of future profits.

When the market is wrong about a stock, it gives savvy investors an opportunity. 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 they key to an excellent investment decision.

You might be able to find a better buy than Star 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).

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.