To the annoyance of some shareholders, Melco Resorts & Entertainment (NASDAQ:MLCO) shares are down a considerable 32% in the last month. That drop has capped off a tough year for shareholders, with the share price down 46% in that time.
Assuming nothing else has changed, a lower share price makes a stock more attractive to potential buyers. In the long term, share prices tend to follow earnings per share, but in the short term prices bounce around in response to short term factors (which are not always obvious). The implication here is that long term investors have an opportunity when expectations of a company are too low. Perhaps the simplest way to get a read on investors' expectations of a business is to look at its Price to Earnings Ratio (PE Ratio). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.
Does Melco Resorts & Entertainment Have A Relatively High Or Low P/E For Its Industry?
Melco Resorts & Entertainment's P/E of 15.73 indicates some degree of optimism towards the stock. The image below shows that Melco Resorts & Entertainment has a higher P/E than the average (12.7) P/E for companies in the hospitality industry.
Its relatively high P/E ratio indicates that Melco Resorts & Entertainment shareholders think it will perform better than other companies in its industry classification. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. Earnings growth means that in the future the 'E' will be higher. That means unless the share price increases, the P/E will reduce in a few years. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Melco Resorts & Entertainment's earnings per share grew by 7.2% in the last twelve months. And its annual EPS growth rate over 3 years is 31%. Unfortunately, earnings per share are down 6.8% a year, over 5 years.
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. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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.
Melco Resorts & Entertainment's Balance Sheet
Net debt totals 52% of Melco Resorts & Entertainment's market cap. If you want to compare its P/E ratio to other companies, you should absolutely keep in mind it has significant borrowings.
The Verdict On Melco Resorts & Entertainment's P/E Ratio
Melco Resorts & Entertainment has a P/E of 15.7. That's higher than the average in its market, which is 13.0. With meaningful debt and only modest recent earnings growth, the market is either expecting reliable long-term growth, or a near-term improvement. Given Melco Resorts & Entertainment's P/E ratio has declined from 23.1 to 15.7 in the last month, we know for sure that the market is significantly less confident about the business today, than it was back then. 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. As value investor Benjamin Graham famously said, 'In the short run, the market is a voting machine but in the long run, it is a weighing machine. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
Of course you might be able to find a better stock than Melco Resorts & Entertainment. So you may wish to see this free collection of other companies that have grown earnings strongly.
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.
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. Thank you for reading.