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This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We'll look at Carnival plc's (LON:CCL) P/E ratio and reflect on what it tells us about the company's share price. Based on the last twelve months, Carnival's P/E ratio is 11.18. In other words, at today's prices, investors are paying £11.18 for every £1 in prior year profit.
Check out our latest analysis for Carnival
How Do I Calculate Carnival's Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share (in the reporting currency) ÷ Earnings per Share (EPS)
Or for Carnival:
P/E of 11.18 = $49.24 (Note: this is the share price in the reporting currency, namely, USD ) ÷ $4.41 (Based on the year to February 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio means that investors are paying a higher price for each £1 of company earnings. 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. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. That means unless the share price increases, the P/E will reduce in a few years. Then, a lower P/E should attract more buyers, pushing the share price up.
It's great to see that Carnival grew EPS by 20% in the last year. And its annual EPS growth rate over 5 years is 27%. So one might expect an above average P/E ratio.
How Does Carnival's P/E Ratio Compare To Its Peers?
One good way to get a quick read on what market participants expect of a company is to look at its P/E ratio. We can see in the image below that the average P/E (17) for companies in the hospitality industry is higher than Carnival's P/E.
Carnival's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Carnival, it's quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
The 'Price' in P/E reflects the market capitalization of the company. That means it doesn't take debt or cash into account. Theoretically, a business can improve its earnings (and produce a lower P/E in the future) by investing in growth. That means taking on debt (or spending its cash).