Here's How P/E Ratios Can Help Us Understand Brinker International, Inc. (NYSE:EAT)

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Today, we'll introduce the concept of the P/E ratio for those who are learning about investing. We'll look at Brinker International, Inc.'s (NYSE:EAT) P/E ratio and reflect on what it tells us about the company's share price. Based on the last twelve months, Brinker International's P/E ratio is 11.06. In other words, at today's prices, investors are paying $11.06 for every $1 in prior year profit.

Check out our latest analysis for Brinker International

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 Brinker International:

P/E of 11.06 = $42.43 ÷ $3.84 (Based on the trailing twelve months to March 2019.)

Is A High Price-to-Earnings Ratio Good?

The higher the P/E ratio, the higher the price tag of a business, relative to its trailing 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.

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 even if the current P/E is high, it will reduce over time if the share price stays flat. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

Notably, Brinker International grew EPS by a whopping 37% in the last year. And its annual EPS growth rate over 5 years is 8.5%. With that performance, I would expect it to have an above average P/E ratio.

How Does Brinker International's P/E Ratio Compare To Its Peers?

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 Brinker International has a lower P/E than the average (23.8) in the hospitality industry classification.

Brinker International's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Many investors like to buy stocks when the market is pessimistic about their prospects. You should delve deeper. I like to check if company insiders have been buying or selling.

Remember: P/E Ratios Don't Consider The Balance Sheet

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. 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.

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 Brinker International's Debt Impact Its P/E Ratio?

Net debt totals 76% of Brinker International's market cap. This is a reasonably significant level of debt -- all else being equal you'd expect a much lower P/E than if it had net cash.

The Verdict On Brinker International's P/E Ratio

Brinker International has a P/E of 11.1. That's below the average in the US market, which is 18.1. The company has a meaningful amount of debt on the balance sheet, but that should not eclipse the solid earnings growth. If the company can continue to grow earnings, then the current P/E may be unjustifiably low.