When close to half the companies in the United States have price-to-earnings ratios (or "P/E's") below 18x, you may consider Choice Hotels International, Inc. (NYSE:CHH) as a stock to potentially avoid with its 26.9x P/E ratio. Nonetheless, we'd need to dig a little deeper to determine if there is a rational basis for the elevated P/E.
With earnings that are retreating more than the market's of late, Choice Hotels International has been very sluggish. It might be that many expect the dismal earnings performance to recover substantially, which has kept the P/E from collapsing. If not, then existing shareholders may be very nervous about the viability of the share price.
What Are Growth Metrics Telling Us About The High P/E?
The only time you'd be truly comfortable seeing a P/E as high as Choice Hotels International's is when the company's growth is on track to outshine the market.
If we review the last year of earnings, dishearteningly the company's profits fell to the tune of 14%. However, a few very strong years before that means that it was still able to grow EPS by an impressive 115% in total over the last three years. Accordingly, while they would have preferred to keep the run going, shareholders would probably welcome the medium-term rates of earnings growth.
Turning to the outlook, the next three years should generate growth of 16% each year as estimated by the eleven analysts watching the company. That's shaping up to be materially higher than the 10% per annum growth forecast for the broader market.
With this information, we can see why Choice Hotels International is trading at such a high P/E compared to the market. It seems most investors are expecting this strong future growth and are willing to pay more for the stock.
The Final Word
It's argued the price-to-earnings ratio is an inferior measure of value within certain industries, but it can be a powerful business sentiment indicator.
We've established that Choice Hotels International maintains its high P/E on the strength of its forecast growth being higher than the wider market, as expected. Right now shareholders are comfortable with the P/E as they are quite confident future earnings aren't under threat. It's hard to see the share price falling strongly in the near future under these circumstances.
Don't forget that there may be other risks. For instance, we've identified 2 warning signs for Choice Hotels International (1 is significant) you should be aware of.
Of course, you might find a fantastic investment by looking at a few good candidates. So take a peek at this free list of companies with a strong growth track record, trading on a low P/E.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
