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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 show how you can use Royal Caribbean Cruises Ltd.’s (NYSE:RCL) P/E ratio to inform your assessment of the investment opportunity. Royal Caribbean Cruises has a price to earnings ratio of 12.57, based on the last twelve months. That means that at current prices, buyers pay $12.57 for every $1 in trailing yearly profits.
How Do You Calculate Royal Caribbean Cruises’s P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Royal Caribbean Cruises:
P/E of 12.57 = $110.4 ÷ $8.78 (Based on the trailing twelve months to March 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. 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.
How Does Royal Caribbean Cruises’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. We can see in the image below that the average P/E (21.6) for companies in the hospitality industry is higher than Royal Caribbean Cruises’s P/E.
This suggests that market participants think Royal Caribbean Cruises will underperform other companies in its industry.
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. 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.
Royal Caribbean Cruises increased earnings per share by an impressive 15% over the last twelve months. And its annual EPS growth rate over 5 years is 35%. This could arguably justify a relatively high P/E ratio.
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. That means it doesn’t take debt or cash into account. 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 expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
Royal Caribbean Cruises’s Balance Sheet
Net debt is 44% of Royal Caribbean Cruises’s market cap. While it’s worth keeping this in mind, it isn’t a worry.
The Bottom Line On Royal Caribbean Cruises’s P/E Ratio
Royal Caribbean Cruises’s P/E is 12.6 which is below average (17.9) in the US market. The EPS growth last year was strong, and debt levels are quite reasonable. The low P/E ratio suggests current market expectations are muted, implying these levels of growth will not continue. Since analysts are predicting growth will continue, one might expect to see a higher P/E so it may be worth looking closer.
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 visual report on analyst forecasts could hold the key to an excellent investment decision.
Of course you might be able to find a better stock than Royal Caribbean Cruises. So you may wish to see this free collection of other companies that have grown earnings strongly.
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 firstname.lastname@example.org. 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.