Unfortunately for some shareholders, the Bowl America (NYSEMKT:BWL.A) share price has dived in the last thirty days. The recent drop has obliterated the annual return, with the share price now down 5.1% over that longer period.
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). 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 Bowl America Have A Relatively High Or Low P/E For Its Industry?
Bowl America's P/E is 26.39. As you can see below Bowl America has a P/E ratio that is fairly close for the average for the hospitality industry, which is 24.6.
Bowl America's P/E tells us that market participants think its prospects are roughly in line with its industry. So if Bowl America actually outperforms its peers going forward, that should be a positive for the share price. Checking factors such as director buying and selling. could help you form your own view on if that will happen.
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. Earnings growth means that in the future the 'E' will be higher. 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.
Bowl America saw earnings per share decrease by 28% last year. But EPS is up 16% over the last 5 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. 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).
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
Bowl America's Balance Sheet
The extra options and safety that comes with Bowl America's US$7.7m 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 Bowl America's P/E Ratio
Bowl America's P/E is 26.4 which is above average (18.9) in its market. Falling earnings per share is probably keeping traditional value investors away, but the relatively strong balance sheet will allow the company time to invest in growth. Clearly, the high P/E indicates shareholders think it will! Given Bowl America's P/E ratio has declined from 26.4 to 26.4 in the last month, we know for sure that the market is less confident about the business today, than it was back then. For those who don't like to trade against momentum, that could be a warning sign, but a contrarian investor might want to take a closer look.
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. Although we don't have analyst forecasts you might want to assess this data-rich visualization of earnings, revenue and cash flow.
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 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.
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