Unfortunately for some shareholders, the Tempur Sealy International (NYSE:TPX) share price has dived 36% in the last thirty days. Indeed, the recent drop has reduced the annual gain to a relatively sedate 3.6% over the last twelve months.
Assuming nothing else has changed, a lower share price makes a stock more 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. The implication here is that long term investors have an opportunity when expectations of a company are too low. One way to gauge market expectations of a stock is to look at its Price to Earnings Ratio (PE Ratio). Investors have optimistic expectations of companies with higher P/E ratios, compared to companies with lower P/E ratios.
How Does Tempur Sealy International’s P/E Ratio Compare To Its Peers?
We can tell from its P/E ratio of 16.86 that there is some investor optimism about Tempur Sealy International. As you can see below, Tempur Sealy International has a higher P/E than the average company (10.2) in the consumer durables industry.
Its relatively high P/E ratio indicates that Tempur Sealy International shareholders think it will perform better than other companies in its industry classification. Shareholders are clearly optimistic, but the future is always uncertain. So investors should delve deeper. I like to check if company insiders have been buying or 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. That’s because companies that grow earnings per share quickly will rapidly increase the ‘E’ in the equation. That means even if the current P/E is high, it will reduce over time if the share price stays flat. And as that P/E ratio drops, the company will look cheap, unless its share price increases.
Tempur Sealy International’s 61% EPS improvement over the last year was like bamboo growth after rain; rapid and impressive.
Don’t Forget: The P/E Does Not Account For Debt or Bank Deposits
The ‘Price’ in P/E reflects the market capitalization of the company. 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.
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.
So What Does Tempur Sealy International’s Balance Sheet Tell Us?
Tempur Sealy International has net debt equal to 44% of its market cap. While it’s worth keeping this in mind, it isn’t a worry.
The Bottom Line On Tempur Sealy International’s P/E Ratio
Tempur Sealy International trades on a P/E ratio of 16.9, which is above its market average of 14.7. The company is not overly constrained by its modest debt levels, and its recent EPS growth is nothing short of stand-out. So on this analysis a high P/E ratio seems reasonable. Given Tempur Sealy International’s P/E ratio has declined from 26.4 to 16.9 in the last month, we know for sure that the market is significantly less confident about the business today, than it was back then. For those who prefer to invest with the flow of momentum, that might be a bad sign, but for a contrarian, it may signal opportunity.
Investors should be looking to buy stocks that the market is wrong about. If the reality for a company is better than it expects, you can make money by buying and holding for the long term. 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.
You might be able to find a better buy than Tempur Sealy International. 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).
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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