Pinnacle Entertainment Inc (NASDAQ:PNK) is trading with a trailing P/E of 27.5x, which is higher than the industry average of 21.8x. While PNK might seem like a stock to avoid or sell if you own it, it is important to understand the assumptions behind the P/E ratio before you make any investment decisions. In this article, I will deconstruct the P/E ratio and highlight what you need to be careful of when using the P/E ratio. Check out our latest analysis for Pinnacle Entertainment

What you need to know about the P/E ratio

The P/E ratio is a popular ratio used in relative valuation since earnings power is a key driver of investment value. By comparing a stock’s price per share to its earnings per share, we are able to see how much investors are paying for each dollar of the company’s earnings.

P/E Calculation for PNK

Price-Earnings Ratio = Price per share ÷ Earnings per share

PNK Price-Earnings Ratio = $30.7 ÷ $1.117 = 27.5x

On its own, the P/E ratio doesn’t tell you much; however, it becomes extremely useful when you compare it with other similar companies. Our goal is to compare the stock’s P/E ratio to the average of companies that have similar attributes to PNK, such as company lifetime and products sold. A common peer group is companies that exist in the same industry, which is what I use. PNK’s P/E of 27.5x is higher than its industry peers (21.8x), which implies that each dollar of PNK’s earnings is being overvalued by investors. As such, our analysis shows that PNK represents an over-priced stock.

A few caveats

While our conclusion might prompt you to sell your PNK shares immediately, there are two important assumptions you should be aware of. Firstly, our peer group contains companies that are similar to PNK. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared higher growth firms with PNK, then its P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing PNK to are fairly valued by the market. If this does not hold true, PNK’s lower P/E ratio may be because firms in our peer group are overvalued by the market.

To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned.