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A Rising Share Price Has Us Looking Closely At MotorCycle Holdings Limited's (ASX:MTO) P/E Ratio

Simply Wall St

Those holding MotorCycle Holdings (ASX:MTO) shares must be pleased that the share price has rebounded 31% in the last thirty days. But unfortunately, the stock is still down by 51% over a quarter. But shareholders may not all be feeling jubilant, since the share price is still down 19% 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. 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 MotorCycle Holdings

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

MotorCycle Holdings's P/E of 6.86 indicates relatively low sentiment towards the stock. The image below shows that MotorCycle Holdings has a lower P/E than the average (10.4) P/E for companies in the specialty retail industry.

ASX:MTO Price Estimation Relative to Market May 11th 2020

This suggests that market participants think MotorCycle Holdings will underperform other companies in its industry. Many investors like to buy stocks when the market is pessimistic about their prospects. If you consider the stock interesting, further research is recommended. For example, I often monitor director buying and 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. So while a stock may look cheap based on past earnings, it could be expensive based on future earnings.

MotorCycle Holdings saw earnings per share decrease by 16% last year. And over the longer term (3 years) earnings per share have decreased 14% annually. This growth rate might warrant a low P/E ratio.

Remember: P/E Ratios Don't Consider The Balance Sheet

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. In theory, a company can lower its future P/E ratio by using cash or debt to invest in growth.

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).

MotorCycle Holdings's Balance Sheet

Net debt totals a substantial 134% of MotorCycle Holdings's market cap. This is a relatively high level of debt, so the stock probably deserves a relatively low P/E ratio. Keep that in mind when comparing it to other companies.

The Bottom Line On MotorCycle Holdings's P/E Ratio

MotorCycle Holdings trades on a P/E ratio of 6.9, which is below the AU market average of 15.0. Given meaningful debt, and a lack of recent growth, the market looks to be extrapolating this recent performance; reflecting low expectations for the future. What is very clear is that the market has become less pessimistic about MotorCycle Holdings over the last month, with the P/E ratio rising from 5.2 back then to 6.9 today. If you like to buy stocks that could be turnaround opportunities, then this one might be a candidate; but if you're more sensitive to price, then you may feel the opportunity has passed.

Investors have an opportunity when market expectations about a stock are wrong. If the reality for a company is not as bad as the P/E ratio indicates, then the share price should increase as the market realizes this. So this free visual report on analyst forecasts could hold the key to an excellent investment decision.

You might be able to find a better buy than MotorCycle Holdings. 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 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.