To the annoyance of some shareholders, Harvey Norman Holdings (ASX:HVN) shares are down a considerable 36% in the last month. Even longer term holders have taken a real hit with the stock declining 19% in the last year.
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.
How Does Harvey Norman Holdings's P/E Ratio Compare To Its Peers?
Harvey Norman Holdings's P/E of 9.20 indicates relatively low sentiment towards the stock. The image below shows that Harvey Norman Holdings has a lower P/E than the average (16.0) P/E for companies in the multiline retail industry.
Its relatively low P/E ratio indicates that Harvey Norman Holdings shareholders think it will struggle to do as well as other companies in its industry classification. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. If you consider the stock interesting, further research is recommended. For example, 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. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.
Harvey Norman Holdings saw earnings per share decrease by 4.2% last year. But it has grown its earnings per share by 7.9% per year over the last five years. And it has shrunk its earnings per share by 4.5% per year over the last three years. This growth rate might warrant a low P/E ratio. So you wouldn't expect a very high P/E.
Remember: P/E Ratios Don't Consider The Balance Sheet
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 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.
So What Does Harvey Norman Holdings's Balance Sheet Tell Us?
Net debt totals 13% of Harvey Norman Holdings's market cap. It would probably deserve a higher P/E ratio if it was net cash, since it would have more options for growth.
The Bottom Line On Harvey Norman Holdings's P/E Ratio
Harvey Norman Holdings has a P/E of 9.2. That's below the average in the AU market, which is 15.9. With only modest debt, it's likely the lack of EPS growth at least partially explains the pessimism implied by the P/E ratio. Given Harvey Norman Holdings's P/E ratio has declined from 14.3 to 9.2 in the last month, we know for sure that the market is more worried about the business today, than it was back then. For those who prefer invest in growth, this stock apparently offers limited promise, but the deep value investors may find the pessimism around this stock enticing.
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.
You might be able to find a better buy than Harvey Norman Holdings. 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.
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