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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 look at Carnival plc’s (LON:CCL) P/E ratio and reflect on what it tells us about the company’s share price. What is Carnival’s P/E ratio? Well, based on the last twelve months it is 11.59. That means that at current prices, buyers pay £11.59 for every £1 in trailing yearly profits.
How Do You Calculate Carnival’s P/E Ratio?
The formula for P/E is:
Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)
Or for Carnival:
P/E of 11.59 = $51.06 (Note: this is the share price in the reporting currency, namely, USD ) ÷ $4.41 (Based on the year to February 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. That isn’t a good or a bad thing on its own, but a high P/E means that buyers have a higher opinion of the business’s prospects, relative to stocks with a lower P/E.
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. 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.
Carnival increased earnings per share by an impressive 20% over the last twelve months. And earnings per share have improved by 27% annually, over the last five years. So one might expect an above average P/E ratio.
Does Carnival Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. We can see in the image below that the average P/E (17.2) for companies in the hospitality industry is higher than Carnival’s P/E.
Its relatively low P/E ratio indicates that Carnival shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. You should delve deeper. I like to check if company insiders have been buying or selling.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The ‘Price’ in P/E reflects the market capitalization of the company. 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.
Is Debt Impacting Carnival’s P/E?
Carnival has net debt equal to 31% of its market cap. While that’s enough to warrant consideration, it doesn’t really concern us.
The Verdict On Carnival’s P/E Ratio
Carnival trades on a P/E ratio of 11.6, which is below the GB market average of 16.2. The company does have a little debt, and EPS growth was good last year. If the company can continue to grow earnings, then the current P/E may be unjustifiably low.
Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
You might be able to find a better buy than Carnival. 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 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.