American Outdoor Brands (NASDAQ:AOBC) shareholders are no doubt pleased to see that the share price has bounced 31% in the last month alone, although it is still down 13% over the last quarter. But shareholders may not all be feeling jubilant, since the share price is still down 17% 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. So some would prefer to hold off buying when there is a lot of optimism towards a stock. 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 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.
How Does American Outdoor Brands's P/E Ratio Compare To Its Peers?
American Outdoor Brands's P/E of 29.76 indicates some degree of optimism towards the stock. You can see in the image below that the average P/E (13.7) for companies in the leisure industry is lower than American Outdoor Brands's P/E.
That means that the market expects American Outdoor Brands will outperform other companies in its industry. Clearly the market expects growth, but it isn't guaranteed. So investors should always consider the P/E ratio alongside other factors, such as whether company directors have been buying shares.
How Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. 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.
American Outdoor Brands shrunk earnings per share by 10% over the last year. And EPS is down 23% a year, over the last 5 years. This could justify a pessimistic P/E.
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. That means it doesn't take debt or cash into account. 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.
While growth expenditure doesn't always pay off, the point is that it is a good option to have; but one that the P/E ratio ignores.
So What Does American Outdoor Brands's Balance Sheet Tell Us?
American Outdoor Brands's net debt equates to 35% of its market capitalization. While it's worth keeping this in mind, it isn't a worry.
The Verdict On American Outdoor Brands's P/E Ratio
American Outdoor Brands has a P/E of 29.8. That's higher than the average in its market, which is 13.6. With modest debt but no EPS growth in the last year, it's fair to say the P/E implies some optimism about future earnings, from the market. What we know for sure is that investors have become much more excited about American Outdoor Brands recently, since they have pushed its P/E ratio from 22.7 to 29.8 over the last month. 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. 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 American Outdoor Brands. 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 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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