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A Rising Share Price Has Us Looking Closely At AutoZone, Inc.'s (NYSE:AZO) P/E Ratio

Simply Wall St

Those holding AutoZone (NYSE:AZO) shares must be pleased that the share price has rebounded 36% in the last thirty days. But unfortunately, the stock is still down by 14% over a quarter. But that gain wasn't enough to make shareholders whole, as the share price is still down 4.2% in the last 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. 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.

See our latest analysis for AutoZone

Does AutoZone Have A Relatively High Or Low P/E For Its Industry?

AutoZone's P/E of 14.76 indicates some degree of optimism towards the stock. You can see in the image below that the average P/E (8.8) for companies in the specialty retail industry is lower than AutoZone's P/E.

NYSE:AZO Price Estimation Relative to Market April 20th 2020

Its relatively high P/E ratio indicates that AutoZone shareholders think it will perform better than other companies in its industry classification. 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

Earnings growth rates have a big influence on P/E ratios. That's because companies that grow earnings per share quickly will rapidly increase the 'E' in the equation. That means unless the share price increases, the P/E will reduce in a few years. A lower P/E should indicate the stock is cheap relative to others -- and that may attract buyers.

Most would be impressed by AutoZone earnings growth of 23% in the last year. And it has bolstered its earnings per share by 14% per year over the last five years. This could arguably justify a relatively high P/E ratio.

A Limitation: P/E Ratios Ignore Debt and Cash In The Bank

It's important to note that the P/E ratio considers the market capitalization, not the enterprise value. 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 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 AutoZone's P/E?

Net debt totals 23% of AutoZone's market cap. This could bring some additional risk, and reduce the number of investment options for management; worth remembering if you compare its P/E to businesses without debt.

The Verdict On AutoZone's P/E Ratio

AutoZone trades on a P/E ratio of 14.8, which is above its market average of 13.6. While the company does use modest debt, its recent earnings growth is very good. So on this analysis it seems reasonable that its P/E ratio is above average. What is very clear is that the market has become more optimistic about AutoZone over the last month, with the P/E ratio rising from 10.8 back then to 14.8 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. People often underestimate remarkable growth -- so investors can make money when fast growth is not fully appreciated. So this free report on the analyst consensus forecasts could help you make a master move on this stock.

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

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.

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. Thank you for reading.