This article is for investors who would like to improve their understanding of price to earnings ratios (P/E ratios). We'll show how you can use Tilly's, Inc.'s (NYSE:TLYS) P/E ratio to inform your assessment of the investment opportunity. Looking at earnings over the last twelve months, Tilly's has a P/E ratio of 11.41. That corresponds to an earnings yield of approximately 8.8%.
How Do You Calculate A P/E Ratio?
The formula for price to earnings is:
Price to Earnings Ratio = Share Price ÷ Earnings per Share (EPS)
Or for Tilly's:
P/E of 11.41 = $9.30 ÷ $0.81 (Based on the year to August 2019.)
Is A High P/E Ratio Good?
A higher P/E ratio implies that investors pay a higher price for the earning power of the business. All else being equal, it's better to pay a low price -- but as Warren Buffett said, 'It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price.
Does Tilly's Have A Relatively High Or Low P/E For Its Industry?
The P/E ratio essentially measures market expectations of a company. The image below shows that Tilly's has a lower P/E than the average (15.2) P/E for companies in the specialty retail industry.
Its relatively low P/E ratio indicates that Tilly's shareholders think it will struggle to do as well as other companies in its industry classification. 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
Generally speaking the rate of earnings growth has a profound impact on a company's P/E multiple. If earnings are growing quickly, then the 'E' in the equation will increase faster than it would otherwise. And in that case, the P/E ratio itself will drop rather quickly. So while a stock may look expensive based on past earnings, it could be cheap based on future earnings.
Tilly's shrunk earnings per share by 10.0% last year. But EPS is up 11% over the last 5 years.
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).
So What Does Tilly's's Balance Sheet Tell Us?
Tilly's has net cash of US$125m. This is fairly high at 45% of its market capitalization. That might mean balance sheet strength is important to the business, but should also help push the P/E a bit higher than it would otherwise be.
The Bottom Line On Tilly's's P/E Ratio
Tilly's's P/E is 11.4 which is below average (17.5) in the US market. The recent drop in earnings per share would almost certainly temper expectations, but the net cash position means the company has time to improve: if so, the low P/E could be an opportunity.
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.
You might be able to find a better buy than Tilly's. 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).
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.
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.