A Sliding Share Price Has Us Looking At Churchill Downs Incorporated’s (NASDAQ:CHDN) P/E Ratio

Unfortunately for some shareholders, the Churchill Downs (NASDAQ:CHDN) share price has dived 32% in the last thirty days. Looking back over the last year, the stock has been a solid performer, with a gain of 20%.

All else being equal, a share price drop should make a stock more attractive to potential investors. While the market sentiment towards a stock is very changeable, in the long run, the share price will tend to move in the same direction as earnings per share. So, on certain occasions, long term focussed investors try to take advantage of pessimistic expectations to buy shares at a better price. One way to gauge market expectations of a stock 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.

See our latest analysis for Churchill Downs

Does Churchill Downs Have A Relatively High Or Low P/E For Its Industry?

Churchill Downs’s P/E of 30.07 indicates some degree of optimism towards the stock. You can see in the image below that the average P/E (16.1) for companies in the hospitality industry is lower than Churchill Downs’s P/E.

NasdaqGS:CHDN Price Estimation Relative to Market, March 10th 2020
NasdaqGS:CHDN Price Estimation Relative to Market, March 10th 2020

Churchill Downs’s P/E tells us that market participants think the company will perform better than its industry peers, going forward. 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

Probably the most important factor in determining what P/E a company trades on is the earnings growth. Earnings growth means that in the future the ‘E’ will be higher. And in that case, the P/E ratio itself will drop rather quickly. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.

Churchill Downs shrunk earnings per share by 21% over the last year. But EPS is up 31% over the last 5 years.

Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits

One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. So it won’t reflect the advantage of cash, or disadvantage of debt. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).

While growth expenditure doesn’t always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.

Is Debt Impacting Churchill Downs’s P/E?

Net debt is 34% of Churchill Downs’s market cap. While that’s enough to warrant consideration, it doesn’t really concern us.

The Bottom Line On Churchill Downs’s P/E Ratio

Churchill Downs trades on a P/E ratio of 30.1, which is above its market average of 15.1. With modest debt but no EPS growth in the last year, it’s fair to say the P/E implies some optimism about future earnings, from the market. Given Churchill Downs’s P/E ratio has declined from 44.4 to 30.1 in the last month, we know for sure that the market is significantly less confident 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 a contrarian, it may signal opportunity.

When the market is wrong about a stock, it gives savvy investors an opportunity. 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.

But note: Churchill Downs may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

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.

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. Thank you for reading.