Unfortunately for some shareholders, the Hudson (NYSE:HUD) share price has dived 67% in the last thirty days. Given the 73% drop over the last year, some shareholders might be worried that they have become bagholders. For those wondering, a bagholder is someone who keeps holding a losing stock indefinitely, without taking the time to consider its prospects carefully, going forward.
Assuming nothing else has changed, a lower share price makes a stock more 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, on certain occasions, long term focussed investors try to take advantage of pessimistic expectations to buy shares at a better price. 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.
Does Hudson Have A Relatively High Or Low P/E For Its Industry?
We can tell from its P/E ratio of 28.01 that there is some investor optimism about Hudson. You can see in the image below that the average P/E (10.3) for companies in the specialty retail industry is lower than Hudson's P/E.
Hudson's P/E tells us that market participants think the company will perform better than its industry peers, going forward. Clearly the market expects growth, but it isn't guaranteed. So further research is always essential. I often monitor director buying and selling.
How Growth Rates Impact P/E Ratios
When earnings fall, the 'E' decreases, over time. 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.
Hudson shrunk earnings per share by 57% over the last year. And it has shrunk its earnings per share by 19% per year over the last three years. This growth rate might warrant a low P/E ratio.
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. So it won't reflect the advantage of cash, or disadvantage of debt. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.
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.
So What Does Hudson's Balance Sheet Tell Us?
Hudson has net debt worth 65% of its market capitalization. This is enough debt that you'd have to make some adjustments before using the P/E ratio to compare it to a company with net cash.
The Verdict On Hudson's P/E Ratio
Hudson has a P/E of 28.0. That's higher than the average in its market, which is 13.8. With significant debt and no EPS growth last year, shareholders are betting on an improvement in earnings from the company. What can be absolutely certain is that the market has become significantly less optimistic about Hudson over the last month, with the P/E ratio falling from 86.0 back then to 28.0 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.
Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. So this free report on the analyst consensus forecasts could help you make a master move on this stock.
You might be able to find a better buy than Hudson. 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 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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