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A Rising Share Price Has Us Looking Closely At Libas Designs Limited's (NSE:LIBAS) P/E Ratio

Simply Wall St

Libas Designs (NSE:LIBAS) shareholders are no doubt pleased to see that the share price has had a great month, posting a 39% gain, recovering from prior weakness. The bad news is that even after that recovery shareholders are still underwater by about 7.3% for the full year.

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. 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). 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.

Check out our latest analysis for Libas Designs

How Does Libas Designs's P/E Ratio Compare To Its Peers?

Libas Designs's P/E of 11.63 indicates some degree of optimism towards the stock. You can see in the image below that the average P/E (10.8) for companies in the luxury industry is lower than Libas Designs's P/E.

NSEI:LIBAS Price Estimation Relative to Market, September 22nd 2019

Libas Designs's P/E tells us that market participants think the company will perform better than its industry peers, going forward. The market is optimistic about the future, but that doesn't guarantee future growth. So investors should delve deeper. I like to check if company insiders have been buying or selling.

How Growth Rates Impact P/E Ratios

If earnings fall then in the future the 'E' will be lower. That means unless the share price falls, the P/E will increase in a few years. A higher P/E should indicate the stock is expensive relative to others -- and that may encourage shareholders to sell.

Libas Designs's earnings made like a rocket, taking off 96% last year. The sweetener is that the annual five year growth rate of 18% is also impressive. So I'd be surprised if the P/E ratio was not above average. Unfortunately, earnings per share are down 5.8% a year, over 3 years.

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. 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.

How Does Libas Designs's Debt Impact Its P/E Ratio?

Libas Designs's net debt is 19% of its market cap. That's enough debt to impact the P/E ratio a little; so keep it in mind if you're comparing it to companies without debt.

The Verdict On Libas Designs's P/E Ratio

Libas Designs trades on a P/E ratio of 11.6, which is below the IN market average of 13.9. The EPS growth last year was strong, and debt levels are quite reasonable. The low P/E ratio suggests current market expectations are muted, implying these levels of growth will not continue. What is very clear is that the market has become more optimistic about Libas Designs over the last month, with the P/E ratio rising from 8.4 back then to 11.6 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.

When the market is wrong about a stock, it gives savvy investors an opportunity. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. Although we don't have analyst forecasts you could get a better understanding of its growth by checking out this more detailed historical graph of earnings, revenue and cash flow.

Of course you might be able to find a better stock than Libas Designs. So you may wish to see this free collection of other companies that have grown earnings strongly.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.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. Thank you for reading.