I am writing today to help inform people who are new to the stock market and want to better understand how you can grow your money by investing in Melco Resorts & Entertainment Limited (NASDAQ:MLCO).
Melco Resorts & Entertainment Limited (NASDAQ:MLCO) trades with a trailing P/E of 34.7x, which is higher than the industry average of 22.9x. Although some investors may jump to the conclusion that you should avoid the stock or sell if you own it, understanding the assumptions behind the P/E ratio might change your mind. In this article, I will explain what the P/E ratio is as well as what you should look out for when using it. Check out our latest analysis for Melco Resorts & Entertainment
Breaking down the Price-Earnings ratio
A common ratio used for relative valuation is the P/E ratio. It compares a stock’s price per share to the stock’s earnings per share. A more intuitive way of understanding the P/E ratio is to think of it as how much investors are paying for each dollar of the company’s earnings.
Price-Earnings Ratio = Price per share ÷ Earnings per share
P/E Calculation for MLCO
Price per share = $27.62
Earnings per share = $0.797
∴ Price-Earnings Ratio = $27.62 ÷ $0.797 = 34.7x
The P/E ratio isn’t a metric you view in isolation and only becomes useful when you compare it against other similar companies. Ideally, we want to compare the stock’s P/E ratio to the average of companies that have similar characteristics as MLCO, such as size and country of operation. A common peer group is companies that exist in the same industry, which is what I use below. Since similar companies should technically have similar P/E ratios, we can very quickly come to some conclusions about the stock if the ratios differ.
Since MLCO’s P/E of 34.7x is higher than its industry peers (22.9x), it means that investors are paying more than they should for each dollar of MLCO’s earnings. Therefore, according to this analysis, MLCO is an over-priced stock.
A few caveats
However, before you rush out to sell your MLCO shares, it is important to note that this conclusion is based on two key assumptions. The first is that our peer group actually contains companies that are similar to MLCO. If this isn’t the case, the difference in P/E could be due to some other factors. For example, if you are inadvertently comparing riskier firms with MLCO, then MLCO’s P/E would naturally be higher than its peers since investors would reward its lower risk with a higher price. The other possibility is if you were accidentally comparing lower growth firms with MLCO. In this case, MLCO’s P/E would be higher since investors would also reward MLCO’s higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing MLCO to are fairly valued by the market. If this assumption does not hold true, MLCO’s higher P/E ratio may be because firms in our peer group are being undervalued by the market.
What this means for you:
If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to rebalance your portfolio and reduce your holdings in MLCO. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I urge you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for MLCO’s future growth? Take a look at our free research report of analyst consensus for MLCO’s outlook.
- Past Track Record: Has MLCO been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of MLCO’s historicals for more clarity.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.