To the annoyance of some shareholders, Mosaic Brands (ASX:MOZ) shares are down a considerable 31% in the last month. That drop has capped off a tough year for shareholders, with the share price down 40% in that time.
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). 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 Mosaic Brands's P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 18.76 that there is some investor optimism about Mosaic Brands. As you can see below, Mosaic Brands has a higher P/E than the average company (14.5) in the specialty retail industry.
Its relatively high P/E ratio indicates that Mosaic Brands shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. So investors should delve deeper. I like to check if company insiders have been buying or selling.
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. When earnings grow, the 'E' increases, over time. And in that case, the P/E ratio itself will drop rather quickly. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.
Mosaic Brands's earnings per share fell by 60% in the last twelve months. But EPS is up 11% over the last 3 years.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
One drawback of using a P/E ratio is that it considers market capitalization, but not the balance sheet. Thus, the metric does not reflect cash or debt held by the company. 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 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.
Is Debt Impacting Mosaic Brands's P/E?
The extra options and safety that comes with Mosaic Brands's AU$6.6m 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 Mosaic Brands's P/E Ratio
Mosaic Brands has a P/E of 18.8. That's around the same as the average in the AU market, which is 18.6. While the lack of recent growth is probably muting optimism, the net cash position means it's not surprising that expectations put the company roughly in line with the market average P/E. What can be absolutely certain is that the market has become significantly less optimistic about Mosaic Brands over the last month, with the P/E ratio falling from 27.2 back then to 18.8 today. 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 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.
But note: Mosaic Brands may not be the best stock to buy. So take a peek at this free list of interesting companies with strong recent earnings growth (and a P/E ratio below 20).
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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