Those holding Card Factory (LON:CARD) shares must be pleased that the share price has rebounded 31% in the last thirty days. But unfortunately, the stock is still down by 16% over a quarter. But that will do little to salve the savage burn caused by the 77% share price decline, over the last year.
Assuming no other changes, a sharply higher share price makes a stock less attractive to potential buyers. 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 some would prefer to hold off buying when there is a lot of optimism towards a stock. One way to gauge market expectations of a stock 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.
See our latest analysis for Card Factory
How Does Card Factory’s P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 2.70 that sentiment around Card Factory isn’t particularly high. We can see in the image below that the average P/E (12.7) for companies in the specialty retail industry is higher than Card Factory’s P/E.
Its relatively low P/E ratio indicates that Card Factory shareholders think it will struggle to do as well as other companies in its industry classification. Since the market seems unimpressed with Card Factory, it’s quite possible it could surprise on the upside. It is arguably worth checking if insiders are buying shares, because that might imply they believe the stock is undervalued.
How Growth Rates Impact P/E Ratios
Companies that shrink earnings per share quickly will rapidly decrease the ‘E’ in the equation. Therefore, even if you pay a low multiple of earnings now, that multiple will become higher in the future. Then, a higher P/E might scare off shareholders, pushing the share price down.
Card Factory’s earnings per share were pretty steady over the last year. But it has grown its earnings per share by 7.3% per year over the last five years. And over the longer term (3 years) earnings per share have decreased 7.8% annually. So we might expect a relatively low P/E.
A Limitation: P/E Ratios Ignore Debt and Cash In The Bank
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.
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 Card Factory’s Balance Sheet Tell Us?
Card Factory has net debt worth a very significant 102% of its market capitalization. This level of debt justifies a relatively low P/E, so remain cognizant of the debt, if you’re comparing it to other stocks.
The Bottom Line On Card Factory’s P/E Ratio
Card Factory’s P/E is 2.7 which is below average (14.7) in the GB market. The meaningful debt load is probably contributing to low expectations, even though it has improved earnings recently. What is very clear is that the market has become less pessimistic about Card Factory over the last month, with the P/E ratio rising from 2.1 back then to 2.7 today. For those who like to invest in turnarounds, that might mean it’s time to put the stock on a watchlist, or research it. But others might consider the opportunity to have passed.
Investors should be looking to buy stocks that the market is wrong about. 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 report on the analyst consensus forecasts could help you make a master move on this stock.
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.
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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. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned. Thank you for reading.
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