City Chic Collective (ASX:CCX) shares have continued recent momentum with a 33% gain in the last month alone. Zooming out, the annual gain of 112% knocks our socks off.
Assuming no other changes, a sharply higher share price makes a stock less attractive to potential buyers. In the long term, share prices tend to follow earnings per share, but in the short term prices bounce around in response to short term factors (which are not always obvious). So some would prefer to hold off buying when there is a lot of optimism towards a stock. Perhaps the simplest way to get a read on investors' expectations of a business is to look at its Price to Earnings Ratio (PE Ratio). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.
Does City Chic Collective Have A Relatively High Or Low P/E For Its Industry?
City Chic Collective's P/E of 39.08 indicates some degree of optimism towards the stock. You can see in the image below that the average P/E (15.7) for companies in the specialty retail industry is lower than City Chic Collective's P/E.
That means that the market expects City Chic Collective will outperform other companies in its industry. Clearly the market expects growth, but it isn't guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. That means even if the current P/E is high, it will reduce over time if the share price stays flat. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
City Chic Collective shrunk earnings per share by 3.8% last year. But it has grown its earnings per share by 2.7% per year over the last five years.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
Don't forget that the P/E ratio considers market capitalization. So it won't reflect the advantage of cash, or disadvantage of debt. 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).
Such spending might be good or bad, overall, but the key point here is that you need to look at debt to understand the P/E ratio in context.
Is Debt Impacting City Chic Collective's P/E?
Since City Chic Collective holds net cash of AU$23m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Bottom Line On City Chic Collective's P/E Ratio
City Chic Collective's P/E is 39.1 which is above average (18.3) in its market. Falling earnings per share is probably keeping traditional value investors away, but the net cash position means the company has time to improve: and the high P/E suggests the market thinks it will. What we know for sure is that investors have become much more excited about City Chic Collective recently, since they have pushed its P/E ratio from 29.4 to 39.1 over the last month. If you like to buy stocks that have recently impressed the market, then this one might be a candidate; but if you prefer to invest when there is 'blood in the streets', then you may feel the opportunity has passed.
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 visual report on analyst forecasts could hold the key to an excellent investment decision.
Of course you might be able to find a better stock than City Chic Collective. So you may wish to see this free collection of other companies that have grown earnings strongly.
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