Unfortunately for some shareholders, the Zumiez (NASDAQ:ZUMZ) share price has dived 31% in the last thirty days. The recent drop has obliterated the annual return, with the share price now down 13% over that longer period.
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. The implication here is that long term investors have an opportunity when expectations of a company are too low. 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 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 Zumiez's P/E Ratio Compare To Its Peers?
Zumiez's P/E of 9.47 indicates relatively low sentiment towards the stock. We can see in the image below that the average P/E (12.1) for companies in the specialty retail industry is higher than Zumiez's P/E.
Zumiez's P/E tells us that market participants think it will not fare as well as its peers in the same industry. Since the market seems unimpressed with Zumiez, it's quite possible it could surprise on the upside. You should delve deeper. I like to check if company insiders have been buying or selling.
How Growth Rates Impact P/E Ratios
P/E ratios primarily reflect market expectations around earnings growth rates. Earnings growth means that in the future the 'E' will be higher. Therefore, even if you pay a high multiple of earnings now, that multiple will become lower in the future. Then, a lower P/E should attract more buyers, pushing the share price up.
Zumiez's 63% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive. Even better, EPS is up 41% per year over three years. So you might say it really deserves to have an above-average 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. Thus, the metric does not reflect cash or debt held by the company. The exact same company would hypothetically deserve a higher P/E ratio if it had a strong balance sheet, than if it had a weak one with lots of debt, because a cashed up company can spend on growth.
Such expenditure might be good or bad, in the long term, but the point here is that the balance sheet is not reflected by this ratio.
So What Does Zumiez's Balance Sheet Tell Us?
With net cash of US$179m, Zumiez has a very strong balance sheet, which may be important for its business. Having said that, at 31% of its market capitalization the cash hoard would contribute towards a higher P/E ratio.
The Bottom Line On Zumiez's P/E Ratio
Zumiez trades on a P/E ratio of 9.5, which is below the US market average of 15.3. Not only should the net cash position reduce risk, but the recent growth has been impressive. The below average P/E ratio suggests that market participants don't believe the strong growth will continue. Because analysts are predicting more growth in the future, one might have expected to see a higher P/E ratio. You can take a closer look at the fundamentals, here. Given Zumiez's P/E ratio has declined from 13.8 to 9.5 in the last month, we know for sure that the market is more worried about the business today, than it was back then. 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 should be looking to buy stocks that the market is wrong about. If it is underestimating a company, investors can make money by buying and holding the shares until the market corrects itself. So this free visualization of the analyst consensus on future earnings could help you make the right decision about whether to buy, sell, or hold.
Of course you might be able to find a better stock than Zumiez. 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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