American Outdoor Brands (NASDAQ:AOBC) shareholders are no doubt pleased to see that the share price has had a great month, posting a 33% gain, recovering from prior weakness. While recent buyers might be laughing, long term holders might not be so pleased, since the recent gain only brings the full year return to evens.
All else being equal, a sharp share price increase should make a stock less attractive to potential investors. While the market sentiment towards a stock is very changeable, in the long run, the share price will tend to move in the same direction as earnings per share. 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.
How Does American Outdoor Brands's P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 35.38 that there is some investor optimism about American Outdoor Brands. The image below shows that American Outdoor Brands has a higher P/E than the average (15.6) P/E for companies in the leisure industry.
Its relatively high P/E ratio indicates that American Outdoor Brands shareholders think it will perform better than other companies in its industry classification. The market is optimistic about the future, but that doesn't guarantee future growth. So further research is always essential. I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. Then, a higher P/E might scare off shareholders, pushing the share price down.
American Outdoor Brands's earnings per share fell by 10% in the last twelve months. And it has shrunk its earnings per share by 23% per year over the last five years. This growth rate might warrant a below average P/E ratio.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
The 'Price' in P/E reflects the market capitalization of the company. That means it doesn't take debt or cash into account. 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 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.
So What Does American Outdoor Brands's Balance Sheet Tell Us?
American Outdoor Brands's net debt equates to 29% of its market capitalization. You'd want to be aware of this fact, but it doesn't bother us.
The Bottom Line On American Outdoor Brands's P/E Ratio
American Outdoor Brands trades on a P/E ratio of 35.4, which is above its market average of 14.3. With some debt but no EPS growth last year, the market has high expectations of future profits. What is very clear is that the market has become significantly more optimistic about American Outdoor Brands over the last month, with the P/E ratio rising from 26.6 back then to 35.4 today. For those who prefer to invest with the flow of momentum, that might mean it's time to put the stock on a watchlist, or research it. But the contrarian may see it as a missed opportunity.
Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
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.
If you spot an error that warrants correction, please contact the editor at firstname.lastname@example.org. 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.
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