Unfortunately for some shareholders, the Tabcorp Holdings (ASX:TAH) share price has dived 31% in the last thirty days. That drop has capped off a tough year for shareholders, with the share price down 48% in that time.
All else being equal, a share price drop should make a stock more attractive to potential investors. While the market sentiment towards a stock is very changeable, in the long run, the share price will tend to move in the same direction as earnings per share. So, on certain occasions, long term focussed investors try to take advantage of pessimistic expectations to buy shares at a better price. One way to gauge market expectations of a stock is to look at its Price to Earnings Ratio (PE Ratio). A high P/E implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.
Does Tabcorp Holdings Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 13.13 that sentiment around Tabcorp Holdings isn't particularly high. We can see in the image below that the average P/E (14.8) for companies in the hospitality industry is higher than Tabcorp Holdings's P/E.
Its relatively low P/E ratio indicates that Tabcorp Holdings 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.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the 'E' increases, over time. And in that case, the P/E ratio itself will drop rather quickly. Then, a lower P/E should attract more buyers, pushing the share price up.
Tabcorp Holdings's 56% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. Having said that, if we look back three years, EPS growth has averaged a comparatively less impressive 2.3%. Unfortunately, earnings per share are down 6.1% a year, over 5 years.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
Don't forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
Tabcorp Holdings's Balance Sheet
Net debt totals 70% of Tabcorp Holdings's market cap. This is enough debt that you'd have to make some adjustments before using the P/E ratio to compare it to a company with net cash.
The Bottom Line On Tabcorp Holdings's P/E Ratio
Tabcorp Holdings has a P/E of 13.1. That's around the same as the average in the AU market, which is 13.0. While it does have meaningful debt levels, it has also produced strong earnings growth recently. The P/E suggests that the market is not convinced EPS will continue to improve strongly. What can be absolutely certain is that the market has become significantly less optimistic about Tabcorp Holdings over the last month, with the P/E ratio falling from 19.1 back then to 13.1 today. For those who prefer to invest with the flow of momentum, that might be a bad sign, but for a contrarian, it may signal opportunity.
Investors have an opportunity when market expectations about a stock are wrong. 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 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 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).
If you spot an error that warrants correction, please contact the editor at email@example.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.
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