To the annoyance of some shareholders, Card Factory (LON:CARD) shares are down a considerable 40% in the last month. Indeed the recent decline has arguably caused some bitterness for shareholders who have held through the 42% drop over twelve months.
All else being equal, a share price drop should make a stock more 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, on certain occasions, long term focussed investors try to take advantage of pessimistic expectations to buy shares at a better price. 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 implies that investors have high expectations of what a company can achieve compared to a company with a low P/E ratio.
Does Card Factory Have A Relatively High Or Low P/E For Its Industry?
Card Factory's P/E of 7.00 indicates relatively low sentiment towards the stock. We can see in the image below that the average P/E (16.6) for companies in the specialty retail industry is higher than Card Factory's P/E.
Card Factory's P/E tells us that market participants think it will not fare as well as its peers in the same industry. While current expectations are low, the stock could be undervalued if the situation is better than the market assumes. 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
Companies that shrink earnings per share quickly will rapidly decrease the 'E' in the equation. That means even if the current P/E is low, it will increase over time if the share price stays flat. Then, a higher P/E might scare off shareholders, pushing the share price down.
Card Factory saw earnings per share decrease by 23% last year. But over the longer term (5 years) earnings per share have increased by 31%. And it has shrunk its earnings per share by 11% per year over the last three years. This could justify a low P/E.
Don't Forget: The P/E Does Not Account For Debt or Bank Deposits
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. In theory, a company can lower its future P/E ratio by using cash or debt to invest in 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.
Card Factory's Balance Sheet
Net debt totals 50% of Card Factory's market cap. If you want to compare its P/E ratio to other companies, you should absolutely keep in mind it has significant borrowings.
The Verdict On Card Factory's P/E Ratio
Card Factory has a P/E of 7.0. That's below the average in the GB market, which is 18.5. When you consider that the company has significant debt, and didn't grow EPS last year, it isn't surprising that the market has muted expectations. What can be absolutely certain is that the market has become more pessimistic about Card Factory over the last month, with the P/E ratio falling from 11.6 back then to 7.0 today. For those who prefer invest in growth, this stock apparently offers limited promise, but the deep value investors may find the pessimism around this stock enticing.
Investors have an opportunity when market expectations about a stock are wrong. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. 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 Card Factory. 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 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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