Those holding J D Wetherspoon (LON:JDW) shares must be pleased that the share price has rebounded 32% in the last thirty days. But unfortunately, the stock is still down by 18% over a quarter. But shareholders may not all be feeling jubilant, since the share price is still down 15% in the last year.
Assuming no other changes, a sharply higher share price makes a stock less 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). The implication here is that deep value investors might steer clear when expectations of a company are too high. 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.
How Does J D Wetherspoon’s P/E Ratio Compare To Its Peers?
J D Wetherspoon has a P/E ratio of 18.96. You can see in the image below that the average P/E (17.9) for companies in the hospitality industry is roughly the same as J D Wetherspoon’s P/E.
That indicates that the market expects J D Wetherspoon will perform roughly in line with other companies in its industry. The company could surprise by performing better than average, in the future. Further research into factors such as insider buying and selling, could help you form your own view on whether that is likely.
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.
J D Wetherspoon saw earnings per share decrease by 3.2% last year. But it has grown its earnings per share by 11% per year over the last five years.
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. 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.
So What Does J D Wetherspoon’s Balance Sheet Tell Us?
Net debt totals 64% of J D Wetherspoon’s market cap. This is a reasonably significant level of debt — all else being equal you’d expect a much lower P/E than if it had net cash.
The Verdict On J D Wetherspoon’s P/E Ratio
J D Wetherspoon’s P/E is 19.0 which is above average (14.4) in its market. With meaningful debt and a lack of recent earnings growth, the market has high expectations that the business will earn more in the future. What is very clear is that the market has become more optimistic about J D Wetherspoon over the last month, with the P/E ratio rising from 14.4 back then to 19.0 today. For those who prefer to invest with the flow of momentum, that might mean it’s time to put the stock on a watchlist, or research it. But the contrarian may see it as a missed 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 visual report on analyst forecasts could hold the key to an excellent investment decision.
You might be able to find a better buy than J D Wetherspoon. 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).
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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.