Despite Its High P/E Ratio, Is SeaLink Travel Group Limited (ASX:SLK) Still Undervalued?

This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll show how you can use SeaLink Travel Group Limited's (ASX:SLK) P/E ratio to inform your assessment of the investment opportunity. What is SeaLink Travel Group's P/E ratio? Well, based on the last twelve months it is 19.09. That means that at current prices, buyers pay A$19.09 for every A$1 in trailing yearly profits.

View our latest analysis for SeaLink Travel Group

How Do You Calculate A P/E Ratio?

The formula for P/E is:

Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)

Or for SeaLink Travel Group:

P/E of 19.09 = A$4 ÷ A$0.21 (Based on the trailing twelve months to December 2018.)

Is A High P/E Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. That isn't necessarily good or bad, but a high P/E implies relatively high expectations of what a company can achieve in the future.

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. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. And as that P/E ratio drops, the company will look cheap, unless its share price increases.

SeaLink Travel Group shrunk earnings per share by 3.8% last year. But EPS is up 18% over the last 5 years.

How Does SeaLink Travel Group's P/E Ratio Compare To Its Peers?

We can get an indication of market expectations by looking at the P/E ratio. As you can see below SeaLink Travel Group has a P/E ratio that is fairly close for the average for the hospitality industry, which is 18.7.

Its P/E ratio suggests that SeaLink Travel Group shareholders think that in the future it will perform about the same as other companies in its industry classification. If the company has better than average prospects, then the market might be underestimating it. Checking factors such as the tenure of the board and management could help you form your own view on if that will happen.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

The 'Price' in P/E reflects the market capitalization of the company. In other words, it does not consider any debt or cash that the company may have on the balance sheet. 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).

How Does SeaLink Travel Group's Debt Impact Its P/E Ratio?

SeaLink Travel Group's net debt is 23% of its market cap. This could bring some additional risk, and reduce the number of investment options for management; worth remembering if you compare its P/E to businesses without debt.

The Verdict On SeaLink Travel Group's P/E Ratio

SeaLink Travel Group's P/E is 19.1 which is above average (16.1) in the AU market. With modest debt but no EPS growth in the last year, it's fair to say the P/E implies some optimism about future earnings, from the market.

Investors have an opportunity when market expectations about a stock are wrong. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

But note: SeaLink Travel Group may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

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.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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.