The Premier Investments (ASX:PMV) share price has done well in the last month, posting a gain of 32%. Unfortunately, the full year gain of 9.6% wasn't so sweet.
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). 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 Premier Investments's P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 29.23 that there is some investor optimism about Premier Investments. The image below shows that Premier Investments has a higher P/E than the average (16.1) P/E for companies in the specialty retail industry.
That means that the market expects Premier Investments will outperform other companies in its industry. 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
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. When earnings grow, the 'E' increases, over time. That means unless the share price increases, the P/E will reduce in a few years. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Premier Investments increased earnings per share by a whopping 27% last year. And its annual EPS growth rate over 5 years is 7.5%. So we'd generally expect it to have a relatively high P/E ratio.
Remember: P/E Ratios Don't Consider The Balance Sheet
The 'Price' in P/E reflects the market capitalization of the company. 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.
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 Premier Investments's Balance Sheet Tell Us?
Since Premier Investments holds net cash of AU$35m, it can spend on growth, justifying a higher P/E ratio than otherwise.
The Verdict On Premier Investments's P/E Ratio
Premier Investments has a P/E of 29.2. That's higher than the average in its market, which is 18.3. Its net cash position supports a higher P/E ratio, as does its solid recent earnings growth. Therefore it seems reasonable that the market would have relatively high expectations of the company What is very clear is that the market has become significantly more optimistic about Premier Investments over the last month, with the P/E ratio rising from 22.1 back then to 29.2 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 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 Premier Investments. 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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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.