This analysis is intended to introduce important early concepts to people who are starting to invest and want to begin learning about how to value company based on its current earnings and what are the drawbacks of this method.
1-800-FLOWERSCOM Inc (NASDAQ:FLWS) trades with a trailing P/E of 17.5x, which is lower than the industry average of 26.8x. While this makes FLWS appear like a great stock to buy, you might change your mind after I explain the assumptions behind the P/E ratio. Today, I will break down what the P/E ratio is, how to interpret it and what to watch out for.
Demystifying the P/E ratio
The P/E ratio is one of many ratios used in relative valuation. It compares a stock’s price per share to the stock’s earnings per share. A more intuitive way of understanding the P/E ratio is to think of it as how much investors are paying for each dollar of the company’s earnings.
P/E Calculation for FLWS
Price-Earnings Ratio = Price per share ÷ Earnings per share
FLWS Price-Earnings Ratio = $11.05 ÷ $0.631 = 17.5x
The P/E ratio itself doesn’t tell you a lot; however, it becomes very insightful when you compare it with other similar companies. We preferably want to compare the stock’s P/E ratio to the average of companies that have similar features to FLWS, such as capital structure and profitability. One way of gathering a peer group is to use firms in the same industry, which is what I’ll do. FLWS’s P/E of 17.5 is lower than its industry peers (26.8), which implies that each dollar of FLWS’s earnings is being undervalued by investors. This multiple is a median of profitable companies of 24 Online Retail companies in US including Liberty Ventures, Liberty Ventures and Acorn International. You can think of it like this: the market is suggesting that FLWS is a weaker business than the average comparable company.
Assumptions to be aware of
However, it is important to note that this conclusion is based on two key assumptions. Firstly, our peer group contains companies that are similar to FLWS. If this isn’t the case, the difference in P/E could be due to other factors. For example, if you compared higher growth firms with FLWS, then its P/E would naturally be lower since investors would reward its peers’ higher growth with a higher price. The second assumption that must hold true is that the stocks we are comparing FLWS to are fairly valued by the market. If this does not hold true, FLWS’s lower P/E ratio may be because firms in our peer group are overvalued by the market.
What this means for you:
If your personal research into the stock confirms what the P/E ratio is telling you, it might be a good time to add more of FLWS to your portfolio. But keep in mind that the usefulness of relative valuation depends on whether you are comfortable with making the assumptions I mentioned above. Remember that basing your investment decision off one metric alone is certainly not sufficient. There are many things I have not taken into account in this article and the PE ratio is very one-dimensional. If you have not done so already, I highly recommend you to complete your research by taking a look at the following:
- Future Outlook: What are well-informed industry analysts predicting for FLWS’s future growth? Take a look at our free research report of analyst consensus for FLWS’s outlook.
- Past Track Record: Has FLWS been consistently performing well irrespective of the ups and downs in the market? Go into more detail in the past performance analysis and take a look at the free visual representations of FLWS’s historicals for more clarity.
- Other High-Performing Stocks: Are there other stocks that provide better prospects with proven track records? Explore our free list of these great stocks here.
To help readers see past the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price-sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned. For errors that warrant correction please contact the editor at firstname.lastname@example.org.