What Choice Hotels International, Inc.'s (NYSE:CHH) P/E Is Not Telling You

Choice Hotels International, Inc.'s (NYSE:CHH) price-to-earnings (or "P/E") ratio of 20x might make it look like a sell right now compared to the market in the United States, where around half of the companies have P/E ratios below 16x and even P/E's below 8x are quite common. Although, it's not wise to just take the P/E at face value as there may be an explanation why it's as high as it is.

Choice Hotels International hasn't been tracking well recently as its declining earnings compare poorly to other companies, which have seen some growth on average. One possibility is that the P/E is high because investors think this poor earnings performance will turn the corner. You'd really hope so, otherwise you're paying a pretty hefty price for no particular reason.

Check out our latest analysis for Choice Hotels International

If you'd like to see what analysts are forecasting going forward, you should check out our free report on Choice Hotels International.

Does Growth Match The High P/E?

The only time you'd be truly comfortable seeing a P/E as high as Choice Hotels International's is when the company's growth is on track to outshine the market.

Retrospectively, the last year delivered a frustrating 9.6% decrease to the company's bottom line. Still, the latest three year period has seen an excellent 190% overall rise in EPS, in spite of its unsatisfying short-term performance. So we can start by confirming that the company has generally done a very good job of growing earnings over that time, even though it had some hiccups along the way.

Turning to the outlook, the next three years should generate growth of 14% each year as estimated by the ten analysts watching the company. That's shaping up to be similar to the 13% per annum growth forecast for the broader market.

With this information, we find it interesting that Choice Hotels International is trading at a high P/E compared to the market. Apparently many investors in the company are more bullish than analysts indicate and aren't willing to let go of their stock right now. These shareholders may be setting themselves up for disappointment if the P/E falls to levels more in line with the growth outlook.

The Key Takeaway

We'd say the price-to-earnings ratio's power isn't primarily as a valuation instrument but rather to gauge current investor sentiment and future expectations.

We've established that Choice Hotels International currently trades on a higher than expected P/E since its forecast growth is only in line with the wider market. Right now we are uncomfortable with the relatively high share price as the predicted future earnings aren't likely to support such positive sentiment for long. This places shareholders' investments at risk and potential investors in danger of paying an unnecessary premium.

Plus, you should also learn about this 1 warning sign we've spotted with Choice Hotels International.

Of course, you might also be able to find a better stock than Choice Hotels International. So you may wish to see this free collection of other companies that have reasonable P/E ratios and have grown earnings strongly.

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This article by Simply Wall St 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. Simply Wall St has no position in any stocks mentioned.