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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll look at Aristocrat Leisure Limited’s (ASX:ALL) P/E ratio and reflect on what it tells us about the company’s share price. Based on the last twelve months, Aristocrat Leisure’s P/E ratio is 28.81. In other words, at today’s prices, investors are paying A$28.81 for every A$1 in prior year profit.
How Do I Calculate Aristocrat Leisure’s Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Aristocrat Leisure:
P/E of 28.81 = A$24.5 ÷ A$0.85 (Based on the trailing twelve months to September 2018.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each A$1 of company earnings. That isn’t a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business’s prospects, relative to stocks with a lower P/E.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the ‘E’ will be higher. That means unless the share price increases, the P/E will reduce in a few years. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Aristocrat Leisure saw earnings per share improve by -9.5% last year. And it has bolstered its earnings per share by 32% per year over the last five years.
How Does Aristocrat Leisure’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. The image below shows that Aristocrat Leisure has a higher P/E than the average (21.3) P/E for companies in the hospitality industry.
Its relatively high P/E ratio indicates that Aristocrat Leisure shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. So further research is always essential. 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 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 Aristocrat Leisure’s Debt Impact Its P/E Ratio?
Aristocrat Leisure’s net debt is 16% 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 Aristocrat Leisure’s P/E Ratio
Aristocrat Leisure’s P/E is 28.8 which is above average (15.2) in the AU market. 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 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 visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
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.
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 firstname.lastname@example.org.