This article is written for those who want to get better at using price to earnings ratios (P/E ratios). We’ll show how you can use The Children’s Place, Inc.’s (NASDAQ:PLCE) P/E ratio to inform your assessment of the investment opportunity. Based on the last twelve months, Children’s Place’s P/E ratio is 14.63. That is equivalent to an earnings yield of about 6.8%.
How Do I Calculate A Price To Earnings Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Price per Share ÷ Earnings per Share (EPS)
Or for Children’s Place:
P/E of 14.63 = $89.29 ÷ $6.1 (Based on the trailing twelve months 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 is not a good or a bad thing per se, but a high P/E does imply buyers are optimistic about the future.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the ‘E’ will be higher. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others — and that may attract buyers.
Children’s Place increased earnings per share by a whopping 26% last year. And earnings per share have improved by 20% annually, over the last five years. With that performance, I would expect it to have an above average P/E ratio.
How Does Children’s Place’s P/E Ratio Compare To Its Peers?
The P/E ratio indicates whether the market has higher or lower expectations of a company. You can see in the image below that the average P/E (15.7) for companies in the specialty retail industry is roughly the same as Children’s Place’s P/E.
Children’s Place’s P/E tells us that market participants think its prospects are roughly in line with its industry. If the company has better than average prospects, then the market might be underestimating it. I inform my view byby checking management tenure and remuneration, among other things.
Remember: P/E Ratios Don’t Consider The Balance Sheet
The ‘Price’ in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
Children’s Place’s Balance Sheet
Children’s Place has net cash of US$20m. That should lead to a higher P/E than if it did have debt, because its strong balance sheets gives it more options.
The Verdict On Children’s Place’s P/E Ratio
Children’s Place trades on a P/E ratio of 14.6, which is below the US market average of 17.4. It grew its EPS nicely over the last year, and the healthy balance sheet implies there is more potential for growth. One might conclude that the market is a bit pessimistic, given the low P/E ratio.
Investors should be looking to buy stocks that the market is wrong about. As value investor Benjamin Graham famously said, ‘In the short run, the market is a voting machine but in the long run, it is a weighing machine.’ So this free report on the analyst consensus forecasts could help you make a master move on this stock.
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 modest (or no) debt, trading on a P/E 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 email@example.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.