Yahoo Finance Should You Be Tempted To Sell Aristocrat Leisure Limited (ASX:ALL) Because Of Its P/E Ratio?
Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll show how you can use Aristocrat Leisure Limited's (ASX:ALL) P/E ratio to inform your assessment of the investment opportunity. Aristocrat Leisure has a price to earnings ratio of 31.14, based on the last twelve months. That corresponds to an earnings yield of approximately 3.2%.
View our latest analysis for Aristocrat Leisure
How Do You Calculate Aristocrat Leisure's P/E 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 31.14 = A$30.86 ÷ A$0.99 (Based on the year to March 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each A$1 the company has earned over the last year. That isn't necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.
Does Aristocrat Leisure 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. As you can see below, Aristocrat Leisure has a higher P/E than the average company (18) 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. The market is optimistic about the future, but that doesn't guarantee future growth. So further research is always essential. I often monitor director buying and 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. When earnings grow, the 'E' increases, over time. That means even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
Notably, Aristocrat Leisure grew EPS by a whopping 26% in the last year. And it has bolstered its earnings per share by 35% per year over the last five years. So we'd generally expect it to have a relatively high P/E ratio.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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).
Aristocrat Leisure's Balance Sheet
Net debt totals 13% of Aristocrat Leisure's market cap. That's enough debt to impact the P/E ratio a little; so keep it in mind if you're comparing it to companies without debt.
The Verdict On Aristocrat Leisure's P/E Ratio
Aristocrat Leisure's P/E is 31.1 which is above average (16.4) in its market. Its debt levels do not imperil its balance sheet and it is growing EPS strongly. Therefore, it's not particularly surprising that it has a above average P/E ratio.
Investors should be looking to buy stocks that the market is wrong about. 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 Aristocrat Leisure. 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).
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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. Thank you for reading.
