Why Great Canadian Gaming Corporation's (TSE:GC) High P/E Ratio Isn't Necessarily A Bad Thing

This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll show how you can use Great Canadian Gaming Corporation's (TSE:GC) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Great Canadian Gaming's P/E ratio is 20.75. That corresponds to an earnings yield of approximately 4.8%.

See our latest analysis for Great Canadian Gaming

How Do I Calculate A Price To Earnings Ratio?

The formula for P/E is:

Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)

Or for Great Canadian Gaming:

P/E of 20.75 = CA$46.46 ÷ CA$2.24 (Based on the year to September 2018.)

Is A High Price-to-Earnings Ratio Good?

A higher P/E ratio means that buyers have to pay a higher price for each CA$1 the company has earned over the last year. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.'

How Growth Rates Impact P/E Ratios

Earnings growth rates have a big influence on P/E ratios. 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.

It's nice to see that Great Canadian Gaming grew EPS by a stonking 57% in the last year. And earnings per share have improved by 16% annually, over the last five years. So we'd generally expect it to have a relatively high P/E ratio.

How Does Great Canadian Gaming's P/E Ratio Compare To Its Peers?

The P/E ratio indicates whether the market has higher or lower expectations of a company. As you can see below, Great Canadian Gaming has a higher P/E than the average company (17.6) in the hospitality industry.

Great Canadian Gaming's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Shareholders are clearly optimistic, but the future is always uncertain. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

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

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.

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.

How Does Great Canadian Gaming's Debt Impact Its P/E Ratio?

Great Canadian Gaming's net debt is 4.6% 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 Verdict On Great Canadian Gaming's P/E Ratio

Great Canadian Gaming trades on a P/E ratio of 20.8, which is above the CA market average of 12.9. Its debt levels do not imperil its balance sheet and it has already proven it can grow. Therefore it seems reasonable that the market would have relatively high expectations of the company

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 freereport on the analyst consensus forecasts could help you make a master move on this stock.

You might be able to find a better buy than Great Canadian Gaming. If you want a selection of possible winners, check out this freelist of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.

Simply Wall St analyst Simply Wall St and Simply Wall St have no position in any of the companies mentioned. This article is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.