A Sliding Share Price Has Us Looking At Darden Restaurants, Inc.’s (NYSE:DRI) P/E Ratio

To the annoyance of some shareholders, Darden Restaurants (NYSE:DRI) shares are down a considerable 65% in the last month. And that drop will have no doubt have some shareholders concerned that the 64% share price decline, over the last year, has turned them into bagholders. For those wondering, a bagholder is someone who keeps holding a losing stock indefinitely, without taking the time to consider its prospects carefully, going forward.

Assuming nothing else has changed, a lower share price makes a stock more attractive to potential buyers. 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.

Check out our latest analysis for Darden Restaurants

How Does Darden Restaurants’s P/E Ratio Compare To Its Peers?

Darden Restaurants’s P/E of 8.26 indicates relatively low sentiment towards the stock. The image below shows that Darden Restaurants has a lower P/E than the average (11.3) P/E for companies in the hospitality industry.

NYSE:DRI Price Estimation Relative to Market, March 20th 2020
NYSE:DRI Price Estimation Relative to Market, March 20th 2020

This suggests that market participants think Darden Restaurants will underperform other companies in its industry. Since the market seems unimpressed with Darden Restaurants, it’s quite possible it could surprise on the upside. If you consider the stock interesting, further research is recommended. For example, 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. When earnings grow, the ‘E’ increases, over time. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.

Darden Restaurants shrunk earnings per share by 6.3% last year. But it has grown its earnings per share by 51% per year over the last five years.

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

Don’t forget that the P/E ratio considers market capitalization. So it won’t reflect the advantage of cash, or disadvantage of debt. 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.

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.

Darden Restaurants’s Balance Sheet

Net debt totals 15% of Darden Restaurants’s market cap. It would probably deserve a higher P/E ratio if it was net cash, since it would have more options for growth.

The Verdict On Darden Restaurants’s P/E Ratio

Darden Restaurants trades on a P/E ratio of 8.3, which is below the US market average of 12.2. The debt levels are not a major concern, but the lack of EPS growth is likely weighing on sentiment. Given Darden Restaurants’s P/E ratio has declined from 23.5 to 8.3 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.

Investors have an opportunity when market expectations about a stock are wrong. 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 report on the analyst consensus forecasts could help you make a master move on this stock.

Of course you might be able to find a better stock than Darden Restaurants. So you may wish to see this free collection of other companies that have grown earnings strongly.

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.

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