Shoe Carnival (NASDAQ:SCVL) shares have had a really impressive month, gaining 39%, after some slippage. But shareholders may not all be feeling jubilant, since the share price is still down 14% in the last year.
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. 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). A high P/E ratio means that investors have a high expectation about future growth, while a low P/E ratio means they have low expectations about future growth.
Does Shoe Carnival Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 12.51 that sentiment around Shoe Carnival isn't particularly high. The image below shows that Shoe Carnival has a lower P/E than the average (14.9) P/E for companies in the specialty retail industry.
This suggests that market participants think Shoe Carnival will underperform other companies in its industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. You should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. When earnings grow, the 'E' increases, over time. 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.
It's nice to see that Shoe Carnival grew EPS by a stonking 33% in the last year. And it has bolstered its earnings per share by 18% per year over the last five years. So we'd generally expect it to have a relatively high P/E ratio.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
Don't forget that the P/E ratio considers market capitalization. Thus, the metric does not reflect cash or debt held by the company. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on 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.
Is Debt Impacting Shoe Carnival's P/E?
The extra options and safety that comes with Shoe Carnival's US$37m net cash position means that it deserves a higher P/E than it would if it had a lot of net debt.
The Verdict On Shoe Carnival's P/E Ratio
Shoe Carnival trades on a P/E ratio of 12.5, which is below the US market average of 17.8. Not only should the net cash position reduce risk, but the recent growth has been impressive. The relatively low P/E ratio implies the market is pessimistic. What is very clear is that the market has become more optimistic about Shoe Carnival over the last month, with the P/E ratio rising from 9.0 back then to 12.5 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 have an opportunity when market expectations about a stock are wrong. 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 Shoe Carnival. 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).
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