This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll look at Scandic Hotels Group AB (publ)'s (STO:SHOT) P/E ratio and reflect on what it tells us about the company's share price. Scandic Hotels Group has a P/E ratio of 10.94, based on the last twelve months. In other words, at today's prices, investors are paying SEK10.94 for every SEK1 in prior year profit.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Scandic Hotels Group:
P/E of 10.94 = SEK81.85 ÷ SEK7.48 (Based on the year to June 2019.)
Is A High Price-to-Earnings Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each SEK1 of company earnings. 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.
Does Scandic Hotels Group Have A Relatively High Or Low P/E For Its Industry?
We can get an indication of market expectations by looking at the P/E ratio. If you look at the image below, you can see Scandic Hotels Group has a lower P/E than the average (15.6) in the hospitality industry classification.
Its relatively low P/E ratio indicates that Scandic Hotels Group shareholders think it will struggle to do as well as other companies in its industry classification. Many investors like to buy stocks when the market is pessimistic about their prospects. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
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. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
It's great to see that Scandic Hotels Group grew EPS by 19% in the last year. And it has improved its earnings per share by 35% per year over the last three years. This could arguably justify a relatively high P/E ratio.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. That means it doesn't take debt or cash into account. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.
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 Scandic Hotels Group's Debt Impact Its P/E Ratio?
Scandic Hotels Group's net debt equates to 50% of its market capitalization. While that's enough to warrant consideration, it doesn't really concern us.
The Bottom Line On Scandic Hotels Group's P/E Ratio
Scandic Hotels Group's P/E is 10.9 which is below average (16.3) in the SE market. 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.
When the market is wrong about a stock, it gives savvy investors an opportunity. 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 report 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 Scandic Hotels Group. 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).
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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. Thank you for reading.