Lithia Motors (NYSE:LAD) shareholders are no doubt pleased to see that the share price has bounced 32% in the last month alone, although it is still down 11% over the last quarter. Longer term shareholders are no doubt thankful for the recovery in the share price, since it's pretty much flat for the year, even after the recent pop.
Assuming no other changes, a sharply higher share price makes a stock less 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 deep value investors might steer clear when expectations of a company are too high. One way to gauge market expectations of a stock 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 Lithia Motors's P/E Ratio Compare To Its Peers?
Lithia Motors has a P/E ratio of 10.29. As you can see below Lithia Motors has a P/E ratio that is fairly close for the average for the specialty retail industry, which is 10.8.
Its P/E ratio suggests that Lithia Motors shareholders think that in the future it will perform about the same as other companies in its industry classification. So if Lithia Motors 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
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. That means even if the current P/E is high, it will reduce over time if the share price stays flat. Then, a lower P/E should attract more buyers, pushing the share price up.
Lithia Motors had pretty flat EPS growth in the last year. But over the longer term (5 years) earnings per share have increased by 14%.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. 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 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.
How Does Lithia Motors's Debt Impact Its P/E Ratio?
Lithia Motors has net debt worth a very significant 130% of its market capitalization. This level of debt justifies a relatively low P/E, so remain cognizant of the debt, if you're comparing it to other stocks.
The Verdict On Lithia Motors's P/E Ratio
Lithia Motors has a P/E of 10.3. That's below the average in the US market, which is 14.8. When you consider that the company has significant debt, and didn't grow EPS last year, it isn't surprising that the market has muted expectations. What we know for sure is that investors have become more excited about Lithia Motors recently, since they have pushed its P/E ratio from 7.8 to 10.3 over the last month. 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. 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 visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
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.
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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.