To the annoyance of some shareholders, Best Buy (NYSE:BBY) shares are down a considerable 33% in the last month. The recent drop has obliterated the annual return, with the share price now down 12% over that longer period.
Assuming nothing else has changed, a lower share price makes a stock more attractive to potential buyers. 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. The implication here is that long term investors have an opportunity when expectations of a company are too low. One way to gauge market expectations of a stock is to look at its Price to Earnings Ratio (PE Ratio). A high P/E implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.
Does Best Buy Have A Relatively High Or Low P/E For Its Industry?
Best Buy has a P/E ratio of 10.50. The image below shows that Best Buy has a P/E ratio that is roughly in line with the specialty retail industry average (10.3).
Its P/E ratio suggests that Best Buy shareholders think that in the future it will perform about the same as other companies in its industry classification. So if Best Buy actually outperforms its peers going forward, that should be a positive for the share price. Further research into factors such as insider buying and selling, could help you form your own view on whether that is likely.
How Growth Rates Impact P/E Ratios
Earnings growth rates have a big influence on P/E ratios. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. Then, a lower P/E should attract more buyers, pushing the share price up.
Best Buy increased earnings per share by an impressive 10% over the last twelve months. And earnings per share have improved by 10% annually, over the last five years. With that performance, you might expect an above average P/E ratio.
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. Thus, the metric does not reflect cash or debt held by the company. 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.
Is Debt Impacting Best Buy's P/E?
The extra options and safety that comes with Best Buy's US$958m 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 Best Buy's P/E Ratio
Best Buy's P/E is 10.5 which is below average (13.8) in the US market. The net cash position gives plenty of options to the business, and the recent improvement in EPS is good to see. One might conclude that the market is a bit pessimistic, given the low P/E ratio. What can be absolutely certain is that the market has become significantly less optimistic about Best Buy over the last month, with the P/E ratio falling from 15.6 back then to 10.5 today. For those who prefer to invest with the flow of momentum, that might be a bad sign, but for a contrarian, it may signal opportunity.
When the market is wrong about a stock, it gives savvy investors an opportunity. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.
You might be able to find a better buy than Best Buy. If you want a selection of possible winners, check out this free list of interesting companies that trade on a P/E below 20 (but have proven they can grow earnings).
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.
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. Thank you for reading.