To the annoyance of some shareholders, Brinker International (NYSE:EAT) shares are down a considerable 65% in the last month. Given the 69% drop over the last year, some shareholders might be worried that they have become bagholders. What is a bagholder? It is a shareholder who has suffered a bad loss, but continues to hold indefinitely, without questioning their reasons for holding, even as the losses grow greater.
Assuming nothing else has changed, a lower share price makes a stock more attractive to potential buyers. In the long term, share prices tend to follow earnings per share, but in the short term prices bounce around in response to short term factors (which are not always obvious). So, on certain occasions, long term focussed investors try to take advantage of pessimistic expectations to buy shares at a better price. Perhaps the simplest way to get a read on investors’ expectations of a business 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 Brinker International’s P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 3.72 that sentiment around Brinker International isn’t particularly high. The image below shows that Brinker International has a lower P/E than the average (10.6) P/E for companies in the hospitality industry.
Its relatively low P/E ratio indicates that Brinker International shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. 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
Generally speaking the rate of earnings growth has a profound impact on a company’s P/E multiple. 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. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Brinker International saw earnings per share improve by 4.0% last year. And earnings per share have improved by 8.7% annually, over the last five 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. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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 Brinker International’s Balance Sheet Tell Us?
Brinker International has net debt worth a very significant 232% of its market capitalization. This level of debt justifies a relatively low P/E, so remain cognizant of the debt, if you’re comparing it to other stocks.
The Verdict On Brinker International’s P/E Ratio
Brinker International has a P/E of 3.7. That’s below the average in the US market, which is 12.4. It’s good to see EPS growth in the last 12 months, but the debt on the balance sheet might be muting expectations. Given Brinker International’s P/E ratio has declined from 10.7 to 3.7 in the last month, we know for sure that the market is more worried about the business today, than it was back then. For those who prefer to invest with the flow of momentum, that might be a bad sign, but for deep value investors this stock might justify some research.
When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. 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 Brinker International. 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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