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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). To keep it practical, we'll show how Tabcorp Holdings Limited's (ASX:TAH) P/E ratio could help you assess the value on offer. Looking at earnings over the last twelve months, Tabcorp Holdings has a P/E ratio of 74.37. That means that at current prices, buyers pay A$74.37 for every A$1 in trailing yearly profits.
See our latest analysis for Tabcorp Holdings
How Do I Calculate A Price To Earnings Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Tabcorp Holdings:
P/E of 74.37 = A$4.57 ÷ A$0.061 (Based on the trailing twelve months to December 2018.)
Is A High P/E Ratio Good?
A higher P/E ratio means that buyers have to pay a higher price for each A$1 the company has earned over the last year. That is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
How Growth Rates Impact P/E Ratios
When earnings fall, the 'E' decreases, over time. That means even if the current P/E is low, it will increase over time if the share price stays flat. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
In the last year, Tabcorp Holdings grew EPS like Taylor Swift grew her fan base back in 2010; the 208% gain was both fast and well deserved. Unfortunately, earnings per share are down 18% a year, over 5 years.
Does Tabcorp Holdings Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio indicates whether the market has higher or lower expectations of a company. As you can see below, Tabcorp Holdings has a much higher P/E than the average company (17.6) in the hospitality industry.
That means that the market expects Tabcorp Holdings will outperform other companies in its industry. Shareholders are clearly optimistic, but the future is always uncertain. So further research is always essential. I often monitor director buying and selling.
Remember: P/E Ratios Don't Consider The Balance Sheet
The 'Price' in P/E reflects the market capitalization of the company. So it won't reflect the advantage of cash, or disadvantage of debt. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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.
How Does Tabcorp Holdings's Debt Impact Its P/E Ratio?
Tabcorp Holdings has net debt equal to 37% of its market cap. You'd want to be aware of this fact, but it doesn't bother us.
The Verdict On Tabcorp Holdings's P/E Ratio
With a P/E ratio of 74.4, Tabcorp Holdings is expected to grow earnings very strongly in the years to come. The company is not overly constrained by its modest debt levels, and its recent EPS growth is nothing short of stand-out. So on this analysis a high P/E ratio seems reasonable.
When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. 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 Tabcorp Holdings. 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).
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 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. Thank you for reading.