It's great to see Leggett & Platt (NYSE:LEG) shareholders have their patience rewarded with a 31% share price pop in the last month. The full year gain of 35% is pretty reasonable, too.
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.
How Does Leggett & Platt's P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 22.99 that there is some investor optimism about Leggett & Platt. The image below shows that Leggett & Platt has a higher P/E than the average (12.8) P/E for companies in the consumer durables industry.
Its relatively high P/E ratio indicates that Leggett & Platt shareholders think it will perform better than other companies in its industry classification. Clearly the market expects growth, but it isn't guaranteed. So investors should delve deeper. I like to check if company insiders have been buying or selling.
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. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.
Leggett & Platt's earnings per share grew by -3.9% in the last twelve months. And earnings per share have improved by 11% annually, over the last five years. Unfortunately, earnings per share are down 5.4% a year, over 3 years.
Remember: P/E Ratios Don't Consider The Balance Sheet
The 'Price' in P/E reflects the market capitalization of the company. Thus, the metric does not reflect cash or debt held by the company. Hypothetically, a company could reduce its future P/E ratio by spending its cash (or taking on debt) to achieve higher earnings.
Spending on growth might be good or bad a few years later, but the point is that the P/E ratio does not account for the option (or lack thereof).
So What Does Leggett & Platt's Balance Sheet Tell Us?
Leggett & Platt's net debt equates to 29% of its market capitalization. While that's enough to warrant consideration, it doesn't really concern us.
The Bottom Line On Leggett & Platt's P/E Ratio
Leggett & Platt has a P/E of 23.0. That's higher than the average in its market, which is 18.0. With modest debt relative to its size, and modest earnings growth, the market is likely expecting sustained long-term growth, if not a near-term improvement. What we know for sure is that investors have become much more excited about Leggett & Platt recently, since they have pushed its P/E ratio from 17.5 to 23.0 over the last month. For those who prefer to invest with the flow of momentum, that might mean it's time to put the stock on a watchlist, or research it. But the contrarian may see it as a missed opportunity.
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 visual report on analyst forecasts could hold the key to an excellent investment decision.
Of course you might be able to find a better stock than Leggett & Platt. 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 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. Thank you for reading.