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Despite Its High P/E Ratio, Is DSW Inc. (NYSE:DSW) Still Undervalued?

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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 DSW Inc.’s (NYSE:DSW) P/E ratio and reflect on what it tells us about the company’s share price. DSW has a P/E ratio of 57.04, based on the last twelve months. That is equivalent to an earnings yield of about 1.8%.

See our latest analysis for DSW

How Do I Calculate A Price To Earnings Ratio?

The formula for P/E is:

Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)

Or for DSW:

P/E of 57.04 = $26.37 ÷ $0.46 (Based on the trailing twelve months to November 2018.)

Is A High P/E Ratio Good?

A higher P/E ratio implies that investors pay a higher price for the earning power of the business. All else being equal, it’s better to pay a low price — but as Warren Buffett said, ‘It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.’

How Growth Rates Impact P/E Ratios

If earnings fall then in the future the ‘E’ will be lower. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. A higher P/E should indicate the stock is expensive relative to others — and that may encourage shareholders to sell.

DSW shrunk earnings per share by 56% over the last year. And it has shrunk its earnings per share by 18% per year over the last five years. This could justify a pessimistic P/E.

How Does DSW’s P/E Ratio Compare To Its Peers?

The P/E ratio indicates whether the market has higher or lower expectations of a company. As you can see below, DSW has a much higher P/E than the average company (16.5) in the specialty retail industry.

NYSE:DSW PE PEG Gauge February 6th 19
NYSE:DSW PE PEG Gauge February 6th 19

DSW’s P/E tells us that market participants think the company will perform better than its industry peers, going forward. Clearly the market expects growth, but it isn’t guaranteed. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.

Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits

It’s important to note that the P/E ratio considers the market capitalization, not the enterprise value. That means it doesn’t take debt or cash into account. 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.

How Does DSW’s Debt Impact Its P/E Ratio?

The extra options and safety that comes with DSW’s US$294m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.

The Bottom Line On DSW’s P/E Ratio

DSW has a P/E of 57. That’s significantly higher than the average in the US market, which is 16.9. The recent drop in earnings per share would make some investors cautious, but the net cash position means the company has time to improve: and the high P/E suggests the market thinks it will.

Investors have an opportunity when market expectations about a stock are wrong. People often underestimate remarkable growth — so investors can make money when fast growth is not fully appreciated. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

But note: DSW may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).

To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.

The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at editorial-team@simplywallst.com.

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