Office Depot (NASDAQ:ODP) shareholders are no doubt pleased to see that the share price has had a great month, posting a 30% gain, recovering from prior weakness. But shareholders may not all be feeling jubilant, since the share price is still down 27% in the last year.
Assuming no other changes, a sharply higher share price makes a stock less 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 deep value investors might steer clear when expectations of a company are too high. Perhaps the simplest way to get a read on investors' expectations of a business 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 Office Depot Have A Relatively High Or Low P/E For Its Industry?
Office Depot's P/E of 34.06 indicates some degree of optimism towards the stock. As you can see below, Office Depot has a higher P/E than the average company (15.4) in the specialty retail industry.
Office Depot's P/E tells us that market participants think the company will perform better than its industry peers, going forward. 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
When earnings fall, the 'E' decreases, over time. That means even if the current P/E is low, it will increase over time if the share price stays flat. Then, a higher P/E might scare off shareholders, pushing the share price down.
Office Depot's earnings per share fell by 70% in the last twelve months. And EPS is down 56% a year, over the last 3 years. This could justify a low P/E.
Remember: P/E Ratios Don't Consider The Balance Sheet
Don't forget that the P/E ratio considers market capitalization. In other words, it does not consider any debt or cash that the company may have on the balance sheet. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
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 Office Depot's P/E?
Office Depot's net debt is 89% of its market cap. If you want to compare its P/E ratio to other companies, you should absolutely keep in mind it has significant borrowings.
The Verdict On Office Depot's P/E Ratio
Office Depot has a P/E of 34.1. That's higher than the average in its market, which is 17.6. With significant debt and no EPS growth last year, shareholders are betting on an improvement in earnings from the company. What is very clear is that the market has become significantly more optimistic about Office Depot over the last month, with the P/E ratio rising from 26.1 back then to 34.1 today. If you like to buy stocks that have recently impressed the market, then this one might be a candidate; but if you prefer to invest when there is 'blood in the streets', then you may feel the opportunity has passed.
Investors should be looking to buy stocks that the market is wrong about. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. 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 Office Depot. 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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