To the annoyance of some shareholders, Indian Hotels (NSE:INDHOTEL) shares are down a considerable 32% in the last month. That drop has capped off a tough year for shareholders, with the share price down 39% in that time.
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. The implication here is that long term investors have an opportunity when expectations of a company are too low. One way to gauge market expectations of a stock is to look at its Price to Earnings Ratio (PE Ratio). A high P/E ratio means that investors have a high expectation about future growth, while a low P/E ratio means they have low expectations about future growth.
Does Indian Hotels Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 26.88 that there is some investor optimism about Indian Hotels. As you can see below, Indian Hotels has a higher P/E than the average company (14.7) in the hospitality industry.
Its relatively high P/E ratio indicates that Indian Hotels shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. So further research is always essential. I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. 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.
In the last year, Indian Hotels grew EPS like Taylor Swift grew her fan base back in 2010; the 58% gain was both fast and well deserved. And earnings per share have improved by 80% annually, over the last three years. So you might say it really deserves to have an above-average P/E ratio.
Remember: P/E Ratios Don’t Consider The Balance Sheet
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. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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.
Indian Hotels’s Balance Sheet
Indian Hotels’s net debt is 9.2% of its market cap. So it doesn’t have as many options as it would with net cash, but its debt would not have much of an impact on its P/E ratio.
The Bottom Line On Indian Hotels’s P/E Ratio
Indian Hotels trades on a P/E ratio of 26.9, which is above its market average of 10.3. While the company does use modest debt, its recent earnings growth is superb. So to be frank we are not surprised it has a high P/E ratio. Given Indian Hotels’s P/E ratio has declined from 39.3 to 26.9 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 don’t like to trade against momentum, that could be a warning sign, but a contrarian investor might want to take a closer look.
Investors have an opportunity when market expectations about a stock are wrong. 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.
You might be able to find a better buy than Indian Hotels. 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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